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    Pay Back period,IRR and NPV

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    On Your Mark is considering purchasing new manufacturing equipment that costs $1,300,000 and is expected to improve cash flows by $500,000 in year 1, $350,000 in year 2, $475,000 in year 3, $450,000 in year 4, and $300,000 in year 5.

    Key financial metrics for this capital budgeting project have been calculated and provided by the Finance department (see below). A 14% rate of return and a payback period of less than five years are required for the project. These key metrics must include (1) payback period, (2) net present value, and (3) internal rate of return. (Use 6% as the weighted average cost of capital).

    Year 0
    Year 1
    Year 2
    Year 3
    Year 4
    Year 5

    (1,300,000)
    500,000
    350,000
    475,000
    450,000
    300,000

    pv

    438,596
    269,314
    320,611
    266,436
    155,811

    NPV

    150,768

    IRR

    19%

    payback

    800,000
    450,000
    (25,000)
    (475,000)
    (775,000)

    MIRR

    17%

    In a memo to the CFO, discuss the metrics and make a recommendation whether to accept or reject the project.

    Choose one metric to begin with (payback, for example). State the pros & cons, the decision (accept/reject) criteria, and whether or not you would accept the project and why (support this with the figures provided). Then, move on to the next metric (NPV, for example) and do the same thing, for all three metrics.

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    Dear student,

    Pay back period;

    Pay back period is the period of time required to recover the initial investment. This is computed by the following formula:
    Payback period; Initial investment/ annual cash inflow

    Annual cash inflow; 355000
    Payback period: 1300000/355000=3.66 years

    In this issue, payback perid is 3.66 years .Therefore, the company can make the purchase of the equipment as the initial investment in the equipment will be recovered from the cash inflows from the equipment in 3.66 years .However, the equipment can provide ...

    Solution Summary

    The solution contains acceptance or rejection of the project by using capital budgeting techniques viz., pay back period, Net present value and Internal rate of return.

    $2.19

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