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Hi can you please explain this question taken from June 2013 exam paper.
A project has an initial outflow of $12000 followed by six equal annual cash inflows, commencing in one years’ time. The payback period is exactly four years . The cost of capital is 12% per year. What is the project’s net present value ( to the nearest $) ?
A. $333
B. $ -2,899
C. $ -3,778
D. $ -5926The correct answer is option A.
An investment project has the following discounted cash flows($’000).
Year Discounted rate
0% 10% 20%
0 (90) (90) (90)
1 30 27.3 25.0
2 30 24.8 29.8
3 30 22.5 17.4
4 30 20.5 14.5
=30 =5.1 = (12.3)The required rate of return on investment is 10% per annum.
What is the discounted payback period of the investment project?
A. Less than 3.0 years
B. 3.0 years
C. Between 3.0 years and 4.0 years
D. More than 4.0 yearsThe correct answer is option C.
And sir the June 2013 question was published in acca practice and revision kit.
1. If the payback period is 4 years and the cash flows are equal each year, then the cash flow each year must be 12,000/4 = $3,000.
The NPV is calculated in the normal way – you get the present value of $3,000 a year for 6 years by multiplying by the 6 year annuity factor at 10%, and then subtract the initial outflow.
2. Only the 10% present values are relevant, and you need the number of years it takes for the total PV to be 90 (the initial outflow).
After three years, the total is 27.3 + 24.8 + 22.5 = 74.6, which is not enough.
After three years the total must be more than 90 (because the NPV is positive), which is enough. So the payback period is between 3 and 4 years.(The first question is indeed from the June 2013 exam. The ACCA do not publish past exams, but if you look at the examiners reports (on the ACCA’s website) they always show three of the exam questions)
I do suggest that you watch the free lectures on investment appraisal.
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