Answer:
Payback period: 4 years
NPV: $87,105
PI: 1.089
IRR: 12.98% (rounded to 2 decimal places)
Explanation:
Payback period is the time taken to recover the initial capital outlay of an investment assuming no interruption of anticipated net cash flow or free cash flow. Computed by dividing initial investment by the anticipated cash flow per year. ($80, 000/$20, 000) = 4 years
Net Present Value (NPV) e is used to analyse the profitability of an investment by discounting future anticipated cash flows. The formula for computing NPV is: [(Cash flows)/(1+r)i] where cash flows is the anticipated cash flow each year,, r is the discount rate, in this case, required rate of return and the i indicated the time period. The NPV is calculated as: [(20,000/(1.1) +20,000/(1.1)^1 +20,000/(1.1)^2 +20,000/(1.1)^3 +20,000/(1.1)^4 +20,000/(1.1)^5 + 20,000/(1.1)^6] = $87, 105
Profitability Index is used to quantify the amount of value created per unit of investment. It is computed as: Net Present Value/ Initial Investment , that is, $87105/$80,000 = 1.089. This means that for every dollar invested, the project generates value of $1.089
Internal Rate of Return (IRR) makes the present value of the project equal to zero. The higher the IRR , the more profitable the project. In this case, the most accurate way this value can be computed is by using a calculator and computing the IRR. N (time period) = 6 , PV(present value of initial investment) = -80, 000, PMT (cashflows per year) = 20,000 Comp I/Y (rate of return) = 12.978%
The variables computed above indicate that undertaking this project would be profitable for the company.
