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I have a very tiny doubt in this problem. Which amount ($5,000 working capital (or) $5,000 further investment at the end of year 4) I should consider with the initial investment of $100,000?
SG Co has been offered with a project. The project will need an initial investment on a non-current asset of $100,000 and a further $5,000 on working capital. The estimated duration of the project would be for 5 years. However, the project would need a further investment of $5,000 at the end of year 4 as SG Co would need to replace one of its machinery. The cash flows from the project would be as follows:
1 $10,000
2 $20,000
3 $30,000
4 $40,000
5 $60,000SG Co’s cost of capital is 10%.
Mr. Drake, finance manager of SG Co, as an initial appraisal of the project, calculate the
discounted payback period. What would be his likely result?Present value table (extracted)
1 0.909
2 0.826
3 0.751
4 0.683
5 0.621a 4 years 8 months
b 4 years 9 months
c 4 years 10 months
d 4 years 11 monthsAnswer is C.
Thank you Mr. John.
1. The working capital needed is included with the initial investment. It will be recovered at the end of the project – time 5.
The additional investment needed of $5,000 is included as a cash outflow at time 4.2. The total initial investment is 105,000. You discount the other flows as normal, and then calculate the payback period on the discounted flows.
Everything you have asked is covered in my free lectures, and you cannot expect me to type out all of my lectures here 🙂
The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
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