# Calculating Payback, NPV and IRR

Winston Clinic is evaluating a project that costs $52,125 and has expected net cash flows of $12,000 per

year for eight years. The first inflow occurs one year after the cost outflow, and the project has a cost of

capital of 12 percent.

a. What is the project's payback?

b. What is the project's NPV? Its IRR?

c. Is the project financially acceptable? Explain your answer.

Better Health, Inc. is evaluating two investment projects, each of which requires an up-front expenditure

of $1.5 million. The projects are expected to produce the following net cash inflows:

Year Project A Project B

0 -$1,500,000 -$1,500,000

1 $500,000 $2,000,000

2 $1,000,000 $1,000,000

3 $2,000,000 $600,000

a. What is each project's IRR?

b. What is each project's NPV if the cost of capital is 10 percent? 5 percent? 15 percent?

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#### Solution Preview

Please refer to the attachments.

1. Winston Clinic is evaluating a project that costs $52,125 and has expected net cash flows of $12,000 per year for eight years. The first inflow occurs one year after the cost outflow, and the project has a cost of capital of 12 percent.

a. What is the project's payback?

Since the cash flow is constant, the payback period is simply the total cost divided by the cash flow. That is 52125/12000 = 4.34 (years)

b. What is the project's NPV? Its IRR?

We can compute the present value (PV) of each cash flow (CF) by the following formula:

PV = CF/(1+12%)year

Year Cash Flow Present Value

0 -52,125 -52,125

1 12,000 10,714

2 12,000 9,566

3 12,000 8,541

4 12,000 7,626

5 12,000 ...

#### Solution Summary

The expert calculates payback, NPV and IRR.

Calculate the required capital budgeting parameters.

1. What is the payback for a project that has anticipated cash inflows of $10,000 for 5 years and a cost of $22,000?

2. Good old XYZorp (they're back!) is considering two mutually exclusive projects, A & B in order to expand their product line. After letting the cost accountants out of their cages, it was determined that project A's initial investment must be $42,400, while project B will cost $60,000.

- Project A has projected cash inflows of $25,000 per year for three years. Project B's inflows are more variable: $10,000 in year 1; $30,000 in year 2; and $40,000 in its final year.

- You have determined the following: the Prime is 7%, LIBOR is 6%, the firm's cost of capital is 12%.

- Using NPV analysis, if the NPV for project B = + $ 1,320 (yes, I ddi the computation for you!), which project do you prefer?

3. Given the information for project A in problem 2, what is this project's IRR?

Assuming a target capital structure of:

40% debt

20% preferred stock

40% common equity

What would be the WACC given the following: all debt will be from the sale of bonds with a coupon of 10% (assume no flotation costs), preferred stock's associated cost will be 13%, and common equity will be from retained earnings with an associated cost of 15%. The tax rate for this corporation is 30%.