UNIVERSITY OF THE IMMACULATE CONCEPTION

Bonifacio St., Davao City

MASTERS IN BUSINESS ADMINISTRATION

Financial Management

NINIO BIONG MANIALAG VINCENT RAY BORON, CPA, MBA

Student Professor

TLA 9. BASIC OF CAPITAL BUDGETING

Problem 11-4: PAYBACK PERIOD. Refer to problem 11-1. What is the project’s payback?
Problem 11-1. Project L costs $65,000, its expected cash inflows are $12,000 per year for 9
years, and its WACC is 9%.
Answer:
Traditional Method of getting Project’s Payback (PBP).
Period Cash Flow Cumulative Cash Flow
0 -$65,000 -$65,000
1 $12,000 -$53,000
2 $12,000 -$41,000
3 $12,000 -$29,000
4 $12,000 -$17,000
5 $12,000 -$5,000
6 $12,000 $7,000

We see from the table above that the recovery was on year 6. Thus, the payback period should
be between 5-6 years.
Solve:
Payback = number of years prior to full recovery + unrecovered cost at start of year
Cash flow during full recovery year
= 5+ $5,000
$12,000
= 5 + 0.41667
PBP = 5.41667 years or 5.42 years (rounded)

Problem 11-5. DISCOUNTED PAYBACK. Refer to problem 11-1. What is the project’s
discounted payback?

Traditional Method of getting Project’s Discounted Payback (PBP).

Period Cash Flow Cumulative Cash Flow
0 -$65,000 -$65,000
1 $12,000 -$53,990.83
2 $12,000 -$43,890.67
3 $12,000 -$34,624.47
4 $12,000 -$26,123.37
5 $12,000 -$18,324.19
6 $12,000 -$11,168.98
7 $12,000 -$4,604.57
8 $12,000 $1,417.83
We see from the table above that the recovery was on year 8. Thus, the payback period should
be between years 7 and 8.

Solve:

Payback = number of years prior to full recovery + unrecovered cost at start of year
Cash flow during full recovery year
= 7+ $4,604.57
$6,022.40
= 7+0.76457
PBP = 7.76457 years or 7.76 years

Problem 11-6. NPV.

Answers:

a.) Project A

Find the NPV. Discount each cash flow to period 0, then find the sum of the PVs to
find NPV.

WACC = 5%
Period Cash Flow ÷ Discount Rate = Discount Cash Flow
0 -$25,000,000 ÷ (1.05)0 = -$25,000,000
1 $5,000,000 ÷ (1.05)1 = $4,761,904.76
2 $10,000,000 ÷ (1.05)2 = $9,070,294.78
3 $17,000,000 ÷ (1.05)3 = $14,685,239.18
Total $3,517,438.72

WACC = 10%
Period Cash Flow ÷ Discount Rate = Discount Cash Flow
0 -$25,000,000 ÷ (1.1)0 = -$25,000,000
1 $5,000,000 ÷ (1.1)1 = $4,545,454.55
2 $10,000,000 ÷ (1.1)2 = $8,264,462.81
3 $17,000,000 ÷ (1.1)3 = $12,772,351.62
Total $582,268.98
 WACC = 15%
Period Cash Flow ÷ Discount Rate = Discount Cash Flow
0 -$25,000,000 ÷ (1.15)0 = -$25,000,000
1 $5,000,000 ÷ (1.15)1 = $4,347,826.09
2 $10,000,000 ÷ (1.15)2 = $7,561,436.67
3 $17,000,000 ÷ (1.15)3 = $11,177,775.95
Total -$1,912,961.29

a.) Project B

Find the NPV. Discount each cash flow to period 0, then find the sum of the PVs to
find NPV.

WACC = 5%
Period Cash Flow ÷ Discount Rate = Discount Cash Flow
0 -$20,000,000 ÷ (1.05)0 = -$20,000,000
1 $10,000,000 ÷ (1.05)1 = $9,523,809.52
2 $9,000,000 ÷ (1.05)2 = $8,163,265.31
3 $6,000,000 ÷ (1.05)3 = $11,177,775.95
Total -$2,870,100.42

WACC = 10%
Period Cash Flow ÷ Discount Rate = Discount Cash Flow
0 -$20,000,000 ÷ (1.1)0 = -$20,000,000
1 $10,000,000 ÷ (1.1)1 = $9,090,909.09
2 $9,000,000 ÷ (1.1)2 = $7,438,016.53
3 $6,000,000 ÷ (1.1)3 = $4,507,888.81
Total $1,036,814.43

WACC = 15%
Period Cash Flow ÷ Discount Rate = Discount Cash Flow
0 -$20,000,000 ÷ (1.15)0 = -$20,000,000
1 $10,000,000 ÷ (1.15)1 = $8,695,652.17
2 $9,000,000 ÷ (1.15)2 = $6,805,293.01
3 $6,000,000 ÷ (1.15)3 = $3,945,097.39
Total -$553,957.43

b.) IRR
This is a problem that can’t be solved through traditional means, equation or
algebra. A financial calculator is needed to solve this problem.

Project A
Find the cash flow editor and input the following:
Period Cash Flow
0 -25
1 5
 2 10
3 17

Then solve for IRR.

Solving for IRR gives us 11.09767%

Project B
Find the cash flow editor and input the following:
Period Cash Flow
0 -20
1 10
2 9
3 6

Then solve for IRR.

Solving for IRR give us 13.17966%

Note:
Some financial calculation does not have a ‘period 0’. In that case, simply treat ‘row 1’ as period
0 and input the rest accordingly.

C. If the WACC is 5% and projects A and B were mutually exclusive, then the project with the
higher NPV will be the better project. In this case, Project A.

If the WACC is 10% and projects A and B were mutually exclusive, then the project with the
higher NPV will be the better project. In this case, Project B.

If the WACC is 15% and projects A and B were mutually exclusive, then the project with the
higher NPV will be the better project. In this case, Project B. However, the NPV of both projects
is negative. Thus, no project will be accepted.

RESULTS:
A.)
NPV at
Project WACC = 5% WACC = 10% WACC = 15%
A $3,517,438.72 $582,268.98 -$1,912,961.29
B $2,870,100.42 $1,036,814.43 -$553,957.43

B.) 11.09767% (Project A); 13.17966% (Project B)

C.) Project A when WACC = 5%
Project B when WACC = 10%
None when WACC = 15%