4f. The estimation of the project’s rate of return using payback’s reciprocal is more appropriate with very long lives.

The payback reciprocal is computed by dividing the digit "1" by a project's payback period expressed in years.

Payback Reciprocal = 1

Payback period = Annual cash flowTotal investment

Payback reciprocal is exactly equal to the unadjusted rate of return. Unadjusted rate means a rate which has not been adjusted by taking into account the time value of money. It is useful where the cash flows is relatively consistent and the life of the asset is at least double the payback period.

8. Investment tax credit (ITC) is an amount that business are allowed by law to deduct from their taxes.

NPV = ∑t=1

n Net cash flow(1+k )t

– Initial cost

= ∑t=1

n DepreciationTax Saving+A−T cost saving(1+k)t

- Initial cost

= ∑t=1

n DepreciationTax Saving(1+k)t

+ ∑t=1

n A−T cost saving(1+k )t

- Initial cost

NPV (A-ITC) – NPV (B-ITC)

= ∑t=1

n DepreciationTax Saving ( A−ITC )−DepreciationTax Saving(B−ITC )(1+k )t

+ 212500(0.1)

= ∑t=1

n 212500(0.1) x Depreciationrate t x Tax rate(1+k )t

+ 212500(0.1) > 0

-> NPV (A-ITC) > NPV (B-ITC)

NPV increases so the acceptability of the project is higher.

2. Net present value of a project or a company is the difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project.

The following is the formula for calculating NPV:

where:

Ct = net cash inflow during the period

Co= initial investment

r = discount rate, and

t = number of time periods

Economic rationale behind the NPV

NPV primarily seeks to identify the most viable investment opportunities by comparing the present value of future cash flows of projects. The rationale behind the NPV method is its focus on the maximization of wealth for business owners or shareholders.

NPV is affected by 4 factors as in the formula

- Cash flow of the project -> CF of each company is different: depreciation expenses of machines are different, tax rate for companies are not the same etc.

- Initial investment -> Not sure other Chicago’s customer would invest how much, whether it is equal to Lone Star’s.

- Discount rate might be the same in one time period

- Time period are the same if investment time of them are equal.