Response:
A. Payback Period
- The payback period is calculated to be 2.875 years, hence the project is deemed acceptable since this period is under the 3-year limit.
B. Internal Rate of Return (IRR)
- With an IRR of 22.69%, the project should be pursued as this rate exceeds the minimum required return of 8%.
C. Simple Rate of Return
- The simple rate of return is 18%, indicating the project should be accepted since it surpasses the required return rate.
D. Net Present Value
- The NPV is calculated at $4,647.85, thus the project should be approved as the NPV is greater than zero.
Clarification:
Year Cash Flow
0 -$10,000
1 $2,400
2 $4,800
3 $3,200
4 $3,200
5 $2,800
6 $2,400
Discount Rate 8%
I employed a financial calculator to find both the NPV and IRR.
Payback period is determined as follows: $10,000 - $2,400 - $4,800 = $2,800 / $3,200 = 0.875
Thus, the payback period is 2.875 years
For simple rate of return:
Average cash flow = ($2,400 + $4,800 + $3,200 + $3,200 + $2,800 + $2,400) / 6 = $3,467
Annual depreciation expense = $10,000 / 6 = $1,667
Simple rate of return = ($3,467 - $1,667) / $10,000 = 18%
