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Company is considering purchase of a new plant and machinery to supplement its
manufacturing process. It has been anticipated that the new plant and machinery will involve an
immediate cash investment of Rs. 500,000 and Rs. 800,000 in year 1. The after-tax cash inflows will
be Rs. 150,000, Rs. 200,000 and Rs. 250,000 for year 2, 3 and 4 respectively. Afterwards, there will
be a cash inflow of Rs. 300,000 each year from year 5 to year 10. Though the plant might be viable
after 10 years but the company prefers to be conservative and end all calculations at that time. The
company’s required rate of return is 14 percent. Considering yourself as financial analyst of the
company, you are required to make the following calculations along with interpretations:
a) What is the project’s payback period? Comment on the feasibility of project by considering
that firm’s required payback period is 5 years.
b) What is the net present value of the project? Is it acceptable?
c) What is the internal rate of return for the project? Is it acceptable? Support your decision
with conceptual rationaleI may be wrong but I’d do it like this:
0 1 2 3 4 5 -10 (annuity)
Investment (500) (800)
After-tax cash inflows 150 200 250 300
net Cash flows (500) (800) 150 200 250 300Discount factor @ 14% 1 0,877 0,769 0,675 0,592 2,302 (5,216-2,914)
Discounted CF (500) (702) 115 135 148 691
NPV (14%) = (113) – NPV negative than project to be rejected based on it
Discount factor @ 5% 1 0,952 0,907 0,864 0,823 4,176
Discounted CF (500) (762) 136 173 206 1253
NPV (5%) = 506IRR = 5%+ 506/(506–113)*(14%-5%)= 12,4% – Lower than cost of capital than project will not be accepted
Payback period: (500)+(800)+150+200+250+300+300=(100) after 6 years+ 100/300 =0,3333 => total 6,33(3) years
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