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# Calculating Payback, NPV and IRR

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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?

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?

#### Solution Preview

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.

\$2.19