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Numerical Models

The document contains a week 2 assignment focused on financial metrics including Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period, and Profitability Index (PI). It provides sample questions and calculations for an investment scenario with an initial outlay of $100,000 and cash inflows over three years. The findings indicate that the investment is not financially viable based on NPV, IRR, and PI results.

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12 views2 pages

Numerical Models

The document contains a week 2 assignment focused on financial metrics including Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period, and Profitability Index (PI). It provides sample questions and calculations for an investment scenario with an initial outlay of $100,000 and cash inflows over three years. The findings indicate that the investment is not financially viable based on NPV, IRR, and PI results.

Uploaded by

yassin.ashraf.11227
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Week 2 Assignment: Sample Questions on NPV, IRR,

Payback Period, and PI


Instructor: Reda M. Hussien
October 19, 2024

Net Present Value (NPV)


Question 1: A company is considering an investment that requires an initial outlay of
$100,000 and is expected to generate the following cash inflows:

• Year 1: $30,000

• Year 2: $40,000

• Year 3: $50,000

The discount rate is 10%. Calculate the Net Present Value (NPV) of the investment.
Answer 1: The formula for NPV is:
X  Ct 
NP V = − C0
(1 + r)t
Where: Ct = Cash inflow at time t r = Discount rate (10% = 0.10) C0 = Initial
investment ($100,000)
     
30, 000 40, 000 50, 000
NP V = + + − 100, 000
(1 + 0.10)1 (1 + 0.10)2 (1 + 0.10)3
     
30, 000 40, 000 50, 000
NP V = + + − 100, 000
1.10 1.21 1.331

N P V = 27, 272.73 + 33, 057.85 + 37, 568.94 − 100, 000 = −2, 100.48
Conclusion: Since the NPV is negative (-$2,100.48), the investment is not financially
viable.

Internal Rate of Return (IRR)


Question 2: Assume the same investment as in Question 1, with an initial outlay of
$100,000 and cash inflows of $30,000, $40,000, and $50,000 in years 1, 2, and 3 respectively.
Find the Internal Rate of Return (IRR).
Answer 2: IRR is the discount rate at which the NPV of the investment equals zero.
The IRR is found by solving the following equation:

1
Week2 Assignment

X Ct

0= − C0
(1 + IRR)t
The IRR is approximately 8.68%.

Payback Period
Question 3: Using the same cash flows as in Questions 1 and 2, calculate the Payback
Period.
Answer 3: The Payback Period is the time it takes for the initial investment to be
recovered through cash inflows.

• Year 1: $30,000

• Year 2: $40,000 (Cumulative: $70,000)

• Year 3: $50,000 (Cumulative: $120,000)

By the end of Year 2, $70,000 has been recovered. The remaining $30,000 is recovered
in Year 3.
To calculate the fraction of Year 3 required to recover $30,000:
30, 000
Fraction of Year 3 = = 0.6 years
50, 000
Payback Period = 2.6 years

Profitability Index (PI)


Question 4: Calculate the Profitability Index (PI) for the investment in Question 1,
with a discount rate of 10%.
Answer 4: The formula for the Profitability Index (PI) is:
P 
Ct
(1+r)t
PI =
C0
Where: Ct = Cash inflows r = Discount rate C0 = Initial investment
27, 272.73 + 33, 057.85 + 37, 568.94
PI =
100, 000
97, 899.52
PI = = 0.979
100, 000
Conclusion: Since the PI is less than 1 (0.979), the investment is not considered
profitable.

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