(i) The payback period for each of the two options. (ii) The net present value for each of the two options. (ii) Based on your analysis, advise Teal as to which of the options, if either, she should choose, outlining any other factors that she should take into account in her decision making.
(i) The payback period for each of the two options. (ii) The net present value for each of the two options. (ii) Based on your analysis, advise Teal as to which of the options, if either, she should choose, outlining any other factors that she should take into account in her decision making.
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Transcribed Image Text:Question 10
Teal's business is growing and she is considering expansion. There are two possible options for
expanding the business. The first is to build an extension to the existing business premises. The
second is to open an additional premises.
Research into these two options has resulted in the following estimates for the next 5 years:
Projected Cash Flows
Year
O (At start)
Extension £000
New Premises £000
Cash outflow
(175)
(269)
1
Cash inflow
52
62
2
Cash inflow
55
67
3
Cash inflow
64
73
4
Cash inflow
65
80
5
Cash inflow
70
82
5
Extra proceeds on sale of business
100
170
Teal requires a return of at least 10% from any project undertaken and whichever option is chosen,
she plans to sell the entire business in 5 years' time.
Assume that the cash flows arise at the end of each year and ignore cash flows arising after this five-
year period.
Calculate:
(i)
The payback period for each of the two options.
(ii)
The net present value for each of the two options.
(ii)
Based on your analysis, advise Teal as to which of the options, if either, she should choose,
outlining any other factors that she should take into account in her decision making.
Expert Solution
Step 1
Payback period
The payback period is the period in which the amount invested in a project is recovered.
Formula = A + B/C
where,
A = Year preceding the year of recovery
B = Amount yet to be recovered
C = Cash inflow during the final year of recovery
Net Present Value
The net present is the difference between the present value of cash outflows and the present value (PV) of cash inflows.
NPV =PV of cash outflows - PV of cash inflows
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