payback period and npa

Question

Mahindra Co Wants to invest in plant costing ₹15,00,000 and has estimated annual

cash inflows to be generated from this plant as ₹500,000, ₹400,000, ₹400,000, ₹500,000,

₹600,000 during its life of five years . The Cost of capital is 10%. the plant also requires

initial working capital investment of ₹2,00,000. It has a salvage value of ₹150,000. Both

working capital and salvage value will be realized in the last year of the project. Find out

the Payback Period and Net Present Value of the investment proposal.

Answer 1

Given:

Initial investment = ₹1,500,000

Cost of capital = (discount rate) = 10% or 10/100 = 0.1

Initial working capital investment = ₹200,000 (realized at the end of 5 years)

Salvage value = ₹150,000 (realized at the end of 5 years)

Initial investment: -1,500,000 and -200,000 for a total of -1,700,000

Year 1 inflow: + 500,000

Year 2 inflow: + 400,000

Year 3 inflow: + 400,000

Year 4 inflow: + 500,000

Year 5 inflow: + 600,000

Also in year 5: + 200,000 initial working capital investment

Also in year 5: + 150,000 salvage value

To calculate payback period:

The company will be generating total cash inflow of ₹1,300,000 in the first 3 years of operation. The 4th year’s inflow of ₹500,000 will bring the total cash inflows to 1,300,000 + 500,000 = ₹1,800,000. This amount is more than the initial investment of ₹1,700,000. So the payback period is somewhere between year 3 and year 4.

After year 3, the company will have ₹1,300,000 cash inflow, so it will be ₹400,000 short (1,700,000 - 1,300,000 = 400,000) of breaking even with its initial investment. So we take ₹400,000 and divide by the amount of inflow the company will generate in the next year (year 4):

400,000 / 500,000 = 0.8 This is the part of the whole year 4 in which enough money will have been generated for the company to cover all of its initial investment. We add this part to the previous full 3 years to get the total payback period:

Payback period = 3 + 0.8 = 3.8 years

To calculate net present value:

Net Present Value = Cash Flow / (1+r)^t - initial investment

We take each of the cash inflows and discount them back to the present time, then subtract the initial investment to get the net present value.

NPV = [500,000/(1+0.1)^1 + 400,000/(1+0.1)^2 + 400,000/(1+0.1)^3 + 500,000/(1+0.1)^4 + 600,000/(1+0.1)^5] + [200,000/(1+0.1)^5 + 150,000/(1+0.1)^5] - 1,700,000 =

= [454,545.45 + 330,578.51 + 300,525.92 + 341,506.73 + 372,552.79] + [124,184.26 + 93,138.20] - 1,700,000 = 317,031.86.

NPV is ₹317,031.86.