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Homework answers / question archive / Alpha Beta Co
Alpha Beta Co. (ABC) is trying to determine the initial outlay of a project. ABC estimates that the project will generate $25,000 net cash flow at the end of each year for 5 years. The project's cost of capital is 11%, and the project has a 10% internal rate of return.
a) What should be the possible initial outlay amounts?
b) what is the payback period and discounted payback period respectively?
a) In order to calculate the initial outlay, use the NPV calculation to find the present value of all cash flows using the following variables:
NPV = 0
IRR = 10%
Net cash flow = $25,000
n = 5 years
0=CF0+25,000(1+0.1)+25,000(1+0.1)2+25,000(1+0.1)3+25,000(1+0.1)4+25,000(1+0.1)50=CF0+25,000(1+0.1)+25,000(1+0.1)2+25,000(1+0.1)3+25,000(1+0.1)4+25,000(1+0.1)5
0=CF0+$94,769.670=CF0+$94,769.67
Therefore, the possible outlay amount should be any amount below $94,769.67
b) The simple payback period is calculated by dividing the initial outlay by the net cash flows:
Payback=94,769.6725000=3.79Payback=94,769.6725000=3.79 years
The discounted payback period is calculated by adding the present value of all cash flows to the initial outlay until an NPV of zero is achieved, using the project's cost of capital as follows:
PV=25,000(1+0.11)+25,000(1+0.11)2+25,000(1+0.11)3+25,000(1+0.11)4+25,000(1+0.11)5PV=25,000(1+0.11)+25,000(1+0.11)2+25,000(1+0.11)3+25,000(1+0.11)4+25,000(1+0.11)5
PV=22,522.52+20,290.56+18,279.78+16,468.27+14,836.28PV=22,522.52+20,290.56+18,279.78+16,468.27+14,836.28
PV=$92,397.43PV=$92,397.43
Because the present value of the discounted cash flows is lower than the initial outlay, the project will have a discounted payback period of greater than 5 years and would therefore represent a negative NPV.
