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Dear Mr Moffat
I have two questions about NPV that I have difficulties.
Could you kindly help me to understand them?Question 1
What is the present value of ten annual payments of $700, the first paid immediately and discounted at 8% given the answer to the nearest $?
Answer is $5,073.
Could you help me to understand how to work out this question? ThanksQuestion 2
Diamond Ltd has payback period limit of three years and is considering investing in one of the following projects. Both projects require an initial investment of $800,000. Cash inflows accrue evenly throughout the year.
What is the payback period?Year Cash Flow
1 250,000
2 350,000
3 400,000
4 200,000
5 150,000
6 150,000
My working
800,000-600,000(250,000+350,000) = 200,000/900,000 equal 2 t=year and 2 months
Book answer
Year Cash Flow Cumulative Cash Inflow
1 250,000 250,000
2 350,000 600,000
3 400,000 1,000,000
4 200,000 1,200,000
5 150,000 1,350,000
6 150,000 1,500,000Payback Period
2 year + 200,000/400,000*12 = 2 years and 6 monthsCould you please explain what is the Cumulative cash inflow and why the payback is 2 years and 6 months?
Thanks in advance for your help
Regards
Gabbi
Question 1:
There is one payment immediately of 700 – the present value of this is 700.
There are then 9 payments of 700, and to get the present value of these you multiply by the 9 year annuity discount factor of 8%.
(Then add the two present values together).
Question 2:
Cumulative simply means total.
What you were doing was correct at the beginning. After 2 years we have a total of 600,000. So we need an additional 200,000.
But it is then you went wrong.In the third year we receive 400,000. So the time to receive the 200,000 we need will be half of the third year (or 6 months).
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