Question

An Engineering Company is considering an investment proposal to install new milling controls. The project cost is `. 50,000. The facility has life of 5 years and no salvage value. The company’s tax rate is 55 %. The estimated cash flows before tax (CFBT) from the proposed investment proposal are as follows:                       4                                                                           

Year CFBT (`)

 1 10,000

 2 11,000

 3 14,000

 4 15,000

 5 25,000

Compute the following:

i) Pay- Back Period

ii) Average rate of return

iii) Net present value at 10% discount rate

iv) Profitability index at 10% discount rate

Answer 1

Answer:

Pay-back period is

= 3 years +$50,000-45,750 \over 16,750$

=3 years + $4,250 \over 16,750$

=3 years +0.25

= 3.25 years

Step 2 (ii) Calculation of Average rate of return-

=$average net profit \over average investment$

=$16,750 \over 25,000$

=67%

Step 3 (iii) Calculation of NPV at 10% discount rate-

Step 4 (iv) Profitability Index @10%-

PI = $PV of cash inflows \over PV of cashflows$ = $62,417.195 \over 50,000$ = 1.248

Therefore,

i) Payback period is 3.25 years.

ii) Average rate of return is 67%.

iii) NPV is 12,417.20

iv) PI is 1.248