Selftest Problems And Solutions

ST15.1 NPV and Payback Period Analysis. Suppose that your college roommate has approached you with an opportunity to invest $25,000 in her fledgling home health-care business. The business, called Home Health Care, Inc., plans to offer home infusion therapy and monitored in-the-home health-care services to surgery patients in the Brainerd, Minnesota, area. The funds would be used to lease a delivery vehicle, to purchase supplies, and for working capital. The terms of the proposal are that you would receive $5,000 at the end of each year in interest on a $25,000 loan to be repaid in full at the end of a 10-year period.

A. Assuming a 10% required rate of return, calculate the present value of cash flows and the net present value of the proposed investment.

B. Based on this same interest-rate assumption, calculate the cumulative cash flow of the proposed investment for each period in both nominal and present-value terms.

C. What is the payback period in both nominal and present-value terms?

D. What is the difference between the nominal and present-value payback period? Can the present-value payback period ever be shorter than the nominal payback period?

ST15.1 Solution

A. The present value of cash flows and the net present value of the proposed investment can be calculated as follows:

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