Calculating Cash Flows, NPV, IRR, and Payback Period for a Project

This assignment provides a detailed financial analysis of a project, including the calculation of cash flows over a four-year period. It determines the Net Present Value (NPV) of the project, considering an initial cash outflow, annual revenues, operating costs, maintenance costs, and depreciation. The analysis also calculates the Internal Rate of Return (IRR) and the payback period to assess the project's financial viability. The assignment compares the project's NPV to an alternative scenario (renting out the building) and provides recommendations based on the IRR, payback period, and NPV results, concluding that the project should be undertaken due to its favorable financial metrics. The analysis emphasizes the importance of the time value of money and considers all cash flows throughout the project's lifespan, highlighting the advantages of using NPV in project evaluation.

Calculation of cash flows
Cost of Equipment ($) = 18000
Life (years) = 4
Salvage Value ($) = 2100
Additional Working Capital ($) = 1500
Particulars Year 1 Year 2 Year 3 Year 4
Revenue 14,500 13,630 12,812 12,043
Operating Cost
-
2,500
-
2,500
-
2,500
-
2,500
Maintenace Cost
-
1,000
-
1,200
-
1,400
-
1,600
Depreciation
-
4,500
-
4,500
-
4,500
-
4,500
Net Profit (Incremental) 6,500 5,430 4,412 3,443
Taxes
-
1,950
-
1,629
-
1,324
-
1,033
4,550 3,801 3,089 2,410
Depreciation 4,500 4,500 4,500 4,500
Regular Cash Flow per year 9,050 8,301 7,589 6,910
Initial Cash Outflow
Cost of Equipment ($) = - 18,000
Additional Working Capital
($) = - 1,500
- 19,500
Terminal Cash Inflow
Salvage Value (Profit) = 2,100
Taxes = - 630
1,470
Working Capital = 1,500
2,970

Year wise cash flow (summary)
Year Cash Flow
0 - 19,500
1 9,050
2 8,301
3 7,589
4 9,880
Calculation of NPV of Project
Year Cash Flow PVF @ 15.02% PV
0 - 19,500 1.0000 - 19,500
1 9,050 0.8694 7,868
2 8,301 0.7559 6,275
3 7,589 0.6572 4,987
4 9,880 0.5714 5,645
5,275
NPV = $5,274.99
Calculation of NPV if rented out
Year
Incremental
Cash flows
PVF @
15.02% PV
0 $0 1.0000 $0.00
1 $1,200 0.8694 $1,043.30
2 $1,200 0.7559 $907.06
3 $1,200 0.6572 $788.61
4 $1,200 0.5714 $685.63
$3,424.59
NPV = $3,424.59

Calculation of Payback Period
Year Cash Flow
Cumulative
Cash Flow
0 - 19,500 - 19,500
1 9,050 - 10,450
2 8,301 - 2,149
3 7,589 5,440
4 9,880 15,320
Payback Period = 2.28 years
Calculation of IRR
Year Cash Flow
0 - 19,500
1 9,050
2 8,301
3 7,589
4 9,880
IRR = 27.81%
Method to be used to evaluate the Project
NPV, IRR and Payback period have its own advantages and disadvantages. However, in
practice, NPV is preferred over other methods because of the following reasons:
1. It considered time value of money.
2. It is easy to calculate.
3. It considers all cash flows during the life of project.
4. Profitability and risk are given high priority.

Recommendation
IRR, Payback period and NPV, all three recommends that project should be undertaken as
1. IRR (27.81%) of the project is more than the cost of capital (15.02%)
2. Payback period (2.28 years) is within the acceptance period of management (4
years).
3. NPV of the project ($$5,274.99) is more than its alternative use of renting out
building ($3,424.59).