[Document title]
[Document subtitle]
VAAL REEFS TECHNICAL HIGH
[COMPANY NAME] [Company address]
, Question 1 [8]
Consider a six-year investment project that requires an initial investment of R280 000 and will pay out the following
at the end of each of the six years.
Year Cash inflow
1 R 50 000
2 R 70 000
3 R 60 000
4 R 65 000
5 R 90 000
6 R 15 000
Model the project in a spreadsheet and use the spreadsheet to answer the following questions:
a. Give the net present value (NPV) and the profitability index (PI) of the project assuming a discount rate of 6%
per annum. (2) b. Would you regard the investment as a good investment? Motivate your answer. (1)
c. How would your answers to question a and b change if the discount rate is assumed to be 8%? (2)
d. Suppose that possible discount rates are 5%, 5.5%, 6%, 6.5%, ..., 9%. Perform a sensitivity analysis on the NPV
and PI of the project for this range of discount rates. Between which two discount rates does the project change
from profitable to unprofitable? Give the NPV and PI values at these two discount rates. (3)
ANSWER :
Question 1
a. The net present value (NPV) and the profitability index (PI) of the project assuming a discount rate of
6% per annum:
To calculate the net present value of the project, we need to discount the cash inflows to their present
value and then subtract the initial investment. We can use the Excel function NPV to do this. The formula
is:
=NPV(discount_rate, cash_flows) - initial_investment
where: discount_rate is 6% per annum
cash_flows are the cash inflows for each year
initial_investment is R280 000.
Using this formula, we get: =NPV(6%, {50000, 70000, 60000, 65000, 90000, 15000}) – 280000
This gives us a net present value of R91 223.11.
To calculate the profitability index, we divide the present value of the cash inflows by the initial investment. The
formula is: =PV(cash_flows, discount_rate) / initial_investment
1
[Document subtitle]
VAAL REEFS TECHNICAL HIGH
[COMPANY NAME] [Company address]
, Question 1 [8]
Consider a six-year investment project that requires an initial investment of R280 000 and will pay out the following
at the end of each of the six years.
Year Cash inflow
1 R 50 000
2 R 70 000
3 R 60 000
4 R 65 000
5 R 90 000
6 R 15 000
Model the project in a spreadsheet and use the spreadsheet to answer the following questions:
a. Give the net present value (NPV) and the profitability index (PI) of the project assuming a discount rate of 6%
per annum. (2) b. Would you regard the investment as a good investment? Motivate your answer. (1)
c. How would your answers to question a and b change if the discount rate is assumed to be 8%? (2)
d. Suppose that possible discount rates are 5%, 5.5%, 6%, 6.5%, ..., 9%. Perform a sensitivity analysis on the NPV
and PI of the project for this range of discount rates. Between which two discount rates does the project change
from profitable to unprofitable? Give the NPV and PI values at these two discount rates. (3)
ANSWER :
Question 1
a. The net present value (NPV) and the profitability index (PI) of the project assuming a discount rate of
6% per annum:
To calculate the net present value of the project, we need to discount the cash inflows to their present
value and then subtract the initial investment. We can use the Excel function NPV to do this. The formula
is:
=NPV(discount_rate, cash_flows) - initial_investment
where: discount_rate is 6% per annum
cash_flows are the cash inflows for each year
initial_investment is R280 000.
Using this formula, we get: =NPV(6%, {50000, 70000, 60000, 65000, 90000, 15000}) – 280000
This gives us a net present value of R91 223.11.
To calculate the profitability index, we divide the present value of the cash inflows by the initial investment. The
formula is: =PV(cash_flows, discount_rate) / initial_investment
1
