Fin 370 Week 4
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Business decisions bring about challenges for any size company. Looking at the case study for Caledonia and developing an answer to the questions and ultimately making a decision on what move is best for the company, at this point learning team A will start research. Using the company data the team will come up with the payback periods, and the internal rate of return. The team will use the results to decide which project will best benefit company operation and finally decide which project will bring profit to the company with the least amount of debt.
12a. What is each projects payback period?
The payback period is a timeframe about when a project is being paid off before it generates revenue.
For project A the payback period is 3.125 years because the company is making $32,000 a year on a project that cost $100,000 to complete. So divide $100,000 into $32,000 it equals 3.125 years
$100000/32000 = 3.125 year
The payback period for project B is 4.5 years, In this case project B for first four years there is no cash flow so no cost recovery on the project. In the fifth year there is revenue of $200,000. So if the $200,000 occurs equally for the entire year, the recovery of $100,000 by mid-year and the rest of the $200,000 is revenue
Divide $100,000 by $200,000 it equals .5 for year five plus the four years of $0.00 revenue resulting in 4.5 years to recover the project cost.
100000/200000 = .5 years. (year 5)
4 years + .5 year = 4.5 years.
12b. What is each projects net present value?
For project A, the present net value is $100,000 the original investment cost of the project is a negative cost because it is an expense to the company. When adding the present annual value of $32,000 for the next five years the group expects, the return rate will be 11% with the use of the annuity table. So for five years the factor will be 3.696 at 11%. To figure out the cash inflow, multiply the annual $32,000 by 3.696 to arrive at $118.272. The total cash inflow over the five years is $118,272 with a net value of $18,272 for project A.
Net present value = $118,272 – $100,000 = $18,272
For project B, the first four years there was no cash flow coming in but in year five there was $200,000 in cash inflow. To find the present value of the $200,000 for the five years, now at 11, use the present value of $1.00 table. The factor of this table will result 0.593. With $200,000 present value in 5 years at 11% would be $200,000 times 0.593, which equals $118,600. So the new present value for project B is $18,600
Net present value = $118,600 – $100,000 = $18,600
12c. What rate of return does this project earn?
“The internal rate of return (IRR) attempts to answer this question: What rate of return does this project earn?,” (Keown, Martin, Petty & Scott, 2005, p. 299). Calculating the internal rate of return provides necessary information such as the discount rate that equates the present value of the future net cash flows against the outlay of cash for the proposed project (Keown et al., 2005). In other words, the calculation determines what the cash inflow is worth at present-day with the value of todays outflow or initial investment into the project. Because the required shareholders required rate of return for this project is 11%, the IRR calculation indicates both Project A and B exceed the expectation. Project A provides a higher rate of return then Project B because both exceed the requirement; either could or should be acceptable projects. Both projects will earn more than the expectation that stockholders anticipate. The calculation of the IRR could be a difficult one, if excel were not available to offer the assistance. A disadvantage of the IRR calculation is the assumption made indicating the reinvesting cash flows at the IRR rate.
Project A
Project B
-100,000
-100000