# Calculating Payback and Profitability

Demonstrate your understanding of financial concepts by completing the following problems. Where appropriate, show or explain your work. You may use Excel to work on the problems.Problem 1. Calculating net present value (NPV): Porter Incorporated has two exclusive projects, listed in the table below. Use the NPV rule to rank these two projects. If the appropriate discount rate is 13 percent, which project should be chosen?Problem 1. Calculating NPVYearProject AProject B0-\$12,700-\$9,4001\$7,000\$4,8002\$5,500\$3,7503\$2,500\$3,400Problem 2. Calculating payback period: An investment project provides cash inflows of \$920 per year for eight years. Calculate the project’s payback period if the initial cost is each of the following:\$4,500.\$5,500.\$7,000.Problem 3. Calculating internal rate of return (IRR) for cash flows: Calculate the internal rate of return for the cash flows of the two projects in the table below.Problem 3. Calculating IRR for Cash FlowsYearProject AProject B0-\$4,600-\$3,5001\$1,400\$1,2502\$2,200\$1,8003\$2,700\$1,600Problem 4. Calculating profitability index of a project: Jeff plans to open a small health club. The equipment will cost \$225,000. Jeff expects that there will be after-tax cash inflows of \$62,000 annually for seven years. The equipment will then be scrapped and the health club will close. At year-end of the first year, the first cash inflow occurs. The required return is 13 percent. What is the project’s profitability index? Should it be accepted?Problem 5. Calculating project NPV: Jenny’s Creamery is considering the purchase of a \$27,000 ice cream maker. The ice cream maker has an economic life of eight years. Using the straight-line method, it will be fully depreciated. The machine will produce 250,000 servings per year, with each costing \$1.25 to make, and priced at \$1.99. The discount rate is 12 percent. The tax rate is 35 percent. Should the company make the purchase? Provide a rationale using the calculations.
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Complete a series of five problems in which you discount the cash flows of
alternative capital investments, compare the expected values of alternative
investments, and choose the investment that will provide maximum value for
shareholders.
Note: The assessments in this course build upon each other, so you are strongly
encouraged to complete them in sequence.
This assessment allows you to demonstrate your understanding of which costs are
important to consider and which are not.
By successfully completing this assessment, you will demonstrate your proficiency
in the following course competencies and assessment objectives:
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Competency 1: Apply the theories, models, and practices of finance to the financial
management of the firm.
Calculate the payback period and net present value (NPV) of a project.
Calculate the internal rate of return (IRR) for the cash flows.
Calculate the profitability index of a project.
Questions to Consider
To deepen your understanding, you are encouraged to consider the questions below
and discuss them with a fellow learner, a work associate, an interested friend, or a
How would you define the following capital budgeting methods: net present value
(NPV), internal rate of return (IRR), and payback period? How do they differ from
one another? What are some other capital budgeting methods? Which, if any, of the
methods might be superior to the others?
What are some concepts associated with making capital investment decisions such
as cash flows, sunk costs, or opportunity costs? Why should an investor factor these
concepts into the decision-making process?
Resources
Suggested Resources
The resources provided here are optional. You may use other resources of your
choice to prepare for this assessment; however, you will need to ensure that they
topics in this unit. The MBA-FP6016  Finance and Value Creation Library Guide can
help direct your research. The Supplemental Resources and Research Resources,
resources to help support you.
The following resources will provide assistance to complete the assessment.
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Assessment Problems  Helpful Tips [DOCX].
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Excel Examples [XLS].
The following texts are designed to assist learners to master core concepts, solve
financial problems, and analyze results.
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https://www.boundless.com/finance/textbooks/boundless-finance-textbook/
Chapter 5, “Time Value Money”.
Chapter 6, “Bond Valuation”
Chapter 7, “Stock Valuation”.
Chapter 15, “Dividends”.
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The following texts are designed to assist learners to master core concepts, solve
financial problems, and analyze results.
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Ross, S. A., Westerfield, R. W., Jaffe, J. F., & Jordan, B. D. (2014). Corporate finance:
Core principles and applications (4th ed.). New York, NY: McGraw-Hill. – Available
from the bookstore
Chapter 7, “Net Present Value and Other Investment Rules,” pages 195229.
Chapter 8, “Making Capital Investment Decisions,” pages 230260.
Chapter 9, “Risk Analysis, Real Options, and Capital Budgeting,” pages 261286.
The text offers an introductory look at corporate finance.
Chapter 15, “Valuation from Comparables and Financial Ratios,” pages 387-421.
Assessment Instructions
Demonstrate your understanding of financial concepts by completing the following
problems. Where appropriate, show or explain your work. You may use Excel to
work on the problems.
Problem 1. Calculating net present value (NPV): Porter Incorporated has two
exclusive projects, listed in the table below. Use the NPV rule to rank these two
projects. If the appropriate discount rate is 13 percent, which project should be
chosen?
Problem 1. Calculating NPV

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Year
Project A
Project B
0
-\$12,700
-\$9,400
1
\$7,000
\$4,800
2
\$5,500
\$3,750
3
\$2,500
\$3,400
Problem 2. Calculating payback period: An investment project provides cash
inflows of \$920 per year for eight years. Calculate the project’s payback period if the
initial cost is each of the following:
\$4,500.
\$5,500.
\$7,000.
Problem 3. Calculating internal rate of return (IRR) for cash flows: Calculate the
internal rate of return for the cash flows of the two projects in the table below.
Problem 3. Calculating IRR for Cash Flows
Year
Project A
Project B
0
-\$4,600
-\$3,500
Problem 3. Calculating IRR for Cash Flows
Year

Project A
Project B
1
\$1,400
\$1,250
2
\$2,200
\$1,800
3
\$2,700
\$1,600
Problem 4. Calculating profitability index of a project: Jeff plans to open a small
health club. The equipment will cost \$225,000. Jeff expects that there will be aftertax cash inflows of \$62,000 annually for seven years. The equipment will then be
scrapped and the health club will close. At year-end of the first year, the first cash
inflow occurs. The required return is 13 percent. What is the project’s profitability
index? Should it be accepted?
Problem 5. Calculating project NPV: Jenny’s Creamery is considering the purchase
of a \$27,000 ice cream maker. The ice cream maker has an economic life of eight
years. Using the straight-line method, it will be fully depreciated. The machine will
produce 250,000 servings per year, with each costing \$1.25 to make, and priced at
\$1.99. The discount rate is 12 percent. The tax rate is 35 percent. Should the
company make the purchase? Provide a rationale using the calculations.

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