Please help me out with 5, 6, 7, and 8, and show all the work You recently went
ID: 2654112 • Letter: P
Question
Please help me out with 5, 6, 7, and 8, and show all the work You recently went to work for Allied Components Company, a supplier of auto repair parts used in the after-market. Your supervisor just handed you the estimated cash flows for two proposed projects. Project L involves adding a new item to the firm?s ignition systems line; it would take some time to build up the market for this product, so the cash inflows would increase over time. Project S involves an add-on to an existing line, and its cash flows would decrease over time. Both projects have three year lives The company believes the risks of the two projects are comparable. Here are the projects? after-tax cash flows (in thousands of dollars): The company?s Weighted Average Cost of Capital is 10%. You must determine whether one or both of the projects should be accepted. 1. Calculate each project?s Net Present Value (N PV). 2. Based on the NPVs, which project(s) should be chosen if the projects are independent? If they are mutually exclusive? 3. Calculate each project?s Profitability Index (Pl). 4. Based on the PIs, which project(s) should be chosen if the projects are independent? If they are mutually exclusive? 5. Calculate each project?s Internal Rate of Return (IRR). 6. Based on the lRRs, which project(s) should be chosen if the projects are independent? If they are mutually exclusive? 7. Calculate each project?s payback period. 8. The company?s maximum acceptable payback period is two years. Based on this maximum payback and the computed payback periods, which project(s) should be chosen if the projects are independent? If they are mutually exclusive?Explanation / Answer
Answer:
5
Calculation of IRR
Project
Initial Investment
CF1
CF2
CF3
IRR
L
-100
10
60
80
18.13%
S
-100
70
50
20
23.56%
6
If projects are independent , then Project S should be chossen asit has higher IRR
If projects are Mutually Exculsive , then we should calculate combined IRR:
Project
Initial Investment
CF1
CF2
CF3
L
-100
10
60
80
S
-100
70
50
20
Combined cash flows
-200
80
110
100
Combined IRR
20.28%
Now if the combined IRR 20.28% is more than the required rate 10% hence both project should be accepted.
7
Calculation of Payback period
Project L
Initial Investment
CF1
CF2
CF3
-100
10
60
80
Cumulative cash flows
-100
-90
-30
50
Payback Period = 2 years +(1 years*30 /80)
= 2.38 Years
Project S
-100
70
50
20
Cumulative cash flows
-100
-30
20
40
Payback Period = 1 years +(1 year*30 /50)
= 1.60 Years
8
Given that co. maximum payback period is 2 years , hence the project having lesser period shall be accepted
In case of independent project
Project S should be accepted
In case of Mutually Exclusive project , we need to calculate combined Payback period
Project
Initial Investment
CF1
CF2
CF3
L
-100
10
60
80
S
-100
70
50
20
Combined cash flows
-200
80
110
100
Cumulative cash flows
-200
-120
-10
90
Payback Period = 2 years + 1year*10/100
= 2.10 year
Hence No project shall be accepted because PBP is more than 2
5
Calculation of IRR
Project
Initial Investment
CF1
CF2
CF3
IRR
L
-100
10
60
80
18.13%
S
-100
70
50
20
23.56%
6
If projects are independent , then Project S should be chossen asit has higher IRR
If projects are Mutually Exculsive , then we should calculate combined IRR:
Project
Initial Investment
CF1
CF2
CF3
L
-100
10
60
80
S
-100
70
50
20
Combined cash flows
-200
80
110
100
Combined IRR
20.28%
Now if the combined IRR 20.28% is more than the required rate 10% hence both project should be accepted.
7
Calculation of Payback period
Project L
Initial Investment
CF1
CF2
CF3
-100
10
60
80
Cumulative cash flows
-100
-90
-30
50
Payback Period = 2 years +(1 years*30 /80)
= 2.38 Years
Project S
-100
70
50
20
Cumulative cash flows
-100
-30
20
40
Payback Period = 1 years +(1 year*30 /50)
= 1.60 Years
8
Given that co. maximum payback period is 2 years , hence the project having lesser period shall be accepted
In case of independent project
Project S should be accepted
In case of Mutually Exclusive project , we need to calculate combined Payback period
Project
Initial Investment
CF1
CF2
CF3
L
-100
10
60
80
S
-100
70
50
20
Combined cash flows
-200
80
110
100
Cumulative cash flows
-200
-120
-10
90
Payback Period = 2 years + 1year*10/100
= 2.10 year
Hence No project shall be accepted because PBP is more than 2