Nebraska Co. is reviewing a capital investment of $100,000. This project's projected cash flows over a five-year period are estimated at $35,000 each year. Required:(a) Calculate the payback period.(b) Calculate the break-even time. Assume a 12% hurdle rate and use the table below:Present ValuePeriods of 1 at 12%1…… 0.89292…… 0.79723…… 0.71184…… 0.63555…… 0.5674(c) Using the results in (a) and (b), make a recommendation for the project.
What will be an ideal response?
| (a) Payback period = $100,000/$35,000 per year = 2.86 years (b) | ||||
| Year | Cash Flow | 12% Discount Factor | Present Value of Cash Flow | Cumulative Present Value of Cash Flow |
| 0… | $(100,000) | ? | ($100,000) | ($100,000) |
| 1… | 35,000 | 0.8929 | 31,252 | (68,748) |
| 2… | 35,000 | 0.7972 | 27,902 | (40,846) |
| 3… | 35,000 | 0.7118 | 24,913 | (15,933) |
| 4… | 35,000 | 0.6355 | 22,242 | 6,309 |
| 5… | 35,000 | 0.5674 | 19,859 | 26,168 |
Break-even time = 3 years + (15,933/22,242) = 3.72 years
(c) If the required payback period is more than 2.86 years, the project is acceptable. If the required break-even time is greater than 3.72 years, the project is acceptable. In addition, the internal rate of return is greater than the 12% hurdle rate.
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