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Solution 1

The company is considering a capital investment project with estimated cash flows over 5 years. The net present value (NPV) of the project is positive at GHC86,743, so the project should be undertaken. The payback period is 1.43 years and the discounted payback period is 1.65 years. The internal rate of return (IRR) is calculated to be 57.23%, which is higher than the company's cost of capital of 12%.

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80 views4 pages

Solution 1

The company is considering a capital investment project with estimated cash flows over 5 years. The net present value (NPV) of the project is positive at GHC86,743, so the project should be undertaken. The payback period is 1.43 years and the discounted payback period is 1.65 years. The internal rate of return (IRR) is calculated to be 57.23%, which is higher than the company's cost of capital of 12%.

Uploaded by

ERIC OWUSU ANSAH
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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QUESTION 1:

A Company Is Considering a Capital Investment, Where the Estimated


Cash Flows Are As Follows;
YEAR CASH FIOW (GHC)
1 (90,000)
2 60,000
3 70,000
4 50,000
5 50,000
The company cost of capital of 12%.also, the capital asset could be
disposed off at the end of year 4 for a scrap value of Ghc 10,000.
Depreciation of the asset is on the straight line base for the 4 years life.
YOU ARE REQUIRED TO CALCULATE:
1. The NPV of the project and to assess whether the project should be
undertaking.
2. The payback and the discounted payback period.
3. Internal rate of return (IRR).

Solution 1:
YEAR CASH FLOW (GHC) D.F
(12%) PV
0 (90,000) 1.0000
(90,000)
1 60,000 0.8929
53,574
2 70,000 0.7972
55,804
3 50,000 0.7118
35,590
4 50,000 0.6355
31,775

NPV
86,743
NB:
WHERE D.F = DISCOUNT FACTOR
PV = PRESENT VALUE
NPV = NET PRESENT VALUE
With the positive NPV, the company should undertake the
project.
NB; year 4 cash flow is made up of scrap value of the asset to
be disposed off and the estimated year 4 cash flow ..
(GHC 10000 + 40000) =GHC 50000.

SOLUTION 2:

PAYBACK PEROID
YEAR CASH FLOW (GHC)
CUMULATIVE CASH FLOW (GHC)
0 (90,000)
(90,000)
1 60,000
(30,000)
2 70,000
40,000
3 50,000
4 50,000

payback period = 1year + 30,000


70,000

= 1.43 years.

DISCOUNTED PAYBACK PERIOD


YEAR CASH FLOW (GHC)
CUMULATIVE CASH FLOW (GHC)
0 (90,000)
(90,000)
1 53,574
(36,426)
2 55804
19,378
3 35590
4 31775

Discounted payback period = 1 year + 36426


55804

= 1.65 years.

SOLUTION 3:

IRR
USING DISCOUNTED FACTOR OF (60%)
YEAR CASH FLOW (GHC) DF (60%)
PV
0 (90,000) 1.0000
(90,000)
1 60,000 0.6250
37,500
2 70,000 0.3906
27,342
3 50,000 0.2441
12,205
4 50,000 0.1526
76,300

NPV
(5,323)
IRR = a% + NPVa * (b% -a %)
NPVa NPVb
Where a% =positive discounting factor
b% = negative discounting factor
NPVa = positive net present value
NPVb = negative net present value
Therefor;
=12% + 86743 * (60% - 12%)
86743 5323

=12% + 8674 * 48%

86743+5323

= 12% + 86743 * 48%


92066

= 12% + 0.9422 * 48% = 57.23%

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