Fin 3322: Cashman
Investment Rules
1. Given the following cash flows for project Z: C0 = -2,000, C1 = 600, C2 = 2160 and
C3= 6000, calculate the discounted payback period for the project at a discount rate
of 20%.
Discounted C0 = -2,000
Discounted C1 = 600/1.2 = 500
Discounted C2 = 2,160/1.2^2 = 1,500
Discounted C3 = 6,000/1.2^3 = 3,472.22
The discounted payback period for the project is 2 years
2. Bill’s Biotech Co. is considering buying a new incubator that will cost $54,200 today.
Net cash flows from the incubator will be $20,608 at the end of each year for the next
five years. Also, at the end of the fifth year, Bill estimates he can sell the incubator
for $13,200. If Bill’s opportunity cost of capital is 15%.
a) What is the incubator’s payback period?
Cash flow is an equal amount each year, so payback
= (54,200/20,608)
= 2.63 years.
b) What is the incubator’s discounted payback period?
Year
Cash
Flow
PV
0
1
2
3
4
5
5
-54,200
20,608
20,608
20,608
20,608
20,608
13,200
17,920
15,582.6
1
13,550.0
9
11,782.6
9
10,245.8
2
6,562.73
Discounted payback = 3.61 years
c) What is the NPV of investing in the incubator?
N = 5; I/Y = 15; PV = ? ; PMT = 20,608; FV = 13,200
PV = 75,643.95
NPV = 75,643.95 – 54,200 = 21,443.95
d) What is the incubator’s IRR?
N = 5; I/Y = ? ; PV = -54,200; PMT = 20,608; FV = 13,200
IRR = 29.59%
e) Should Bill buy the new incubator? Explain why/why not?
Yes – positive NPV, so it adds to shareholder wealth.
3. A project has net income of $1,800, $2,000, $2,200, and $2,400 a year over its 4-year
life. The initial cost of the project is $65,000, which will be depreciated using
straight-line depreciation to a book value of zero over the life of the project. The firm
wants to earn a minimal average accounting return of 8.5%. The firm should _____
the project based on the AAR of _____.
0
NI
1
2
3
1800
2000
2200
4 Average AAR
2400
2,100
=2100/32,500
=0.064615
BV
65,000 48,750 32,500 16,250
0
32,500
Reject the project based on the AAR 6.46% < 8.5%
4. What is the profitability index for an investment with the following cash flows given
a 9% required return? Cost $21,500, then yearly revenue of $7,400, $9,800, and
$8,900.
Year
0
1
2
3
Cash Flow
-21,500.00
7,400.00
9,800.00
8,900.00
PI =
21,909.89/21,500
PV
6,788.99
8,248.46
6,872.43
21,909.89
1.02