Quattro, Inc. has the following mutually exclusive projects available. The compa
ID: 2708315 • Letter: Q
Question
Quattro, Inc. has the following mutually exclusive projects available. The company has historically used a 2.5-year cutoff for projects. The required return is 14 percent.
Year: Cash flow (A) Cash flow (B)
0 -$54,000 -$23,000
1 12,700 11,600
2 23,200 11,200
3 27,600 12,500
4 46,500 6,000
a. What are the payback periods for project A and B? Based on payback rule, which project would the firm choose?
b. What are the NPVs for project A and B? Based on NPV rule, which project, if any, should the company accept?
c. What are the IRRs for project A and B? Based on IRR rule, which project, if any, should the company accept?
Based on the above answers, which project will you finally choose? Why?
Explanation / Answer
PAYBACK PERIOD FOR A = 2 + (54000-12700-23200)/27600
=2 + 0.25
=2.25 YEARS
PAYBACK PERIOD FOR B = 2 + (23000-11600-11200)/12500
=2+ 0.016
=2.016 YEARS
BASED ON PAYBACK PERIOD WE SHOUL CHOOSE B
NPV FOR A = 12700/(1.14) + 23200/(1.14)^2 + 27600/(1.14)^3 + 46500/(1.14)^4 - 54000
=21152.94
NPV FOR B = 11600/(1.14) + 11200/(1.14)^2 + 12500/(1.14)^3 + 6000/(1.14)^4 - 23000
=7783.1
BASED ON NPV WE SHOULD ACCEPT A
IRR
AT IRR , PV OF OUTFLOWS = PV OF INFLOWS
A
54000 = 12700/(1+IRR) + 23200/(1+IRR)^2 + 27600/(1+IRR)^3 + 46500/(1+IRR)^4
BY COMPUTING WE GET IRR = 28.5%
B
23000 = 11600/(1+IRR) + 11200/(1+IRR)^2 + 12500/(1+IRR)^3 + 6000/(1+IRR)^4
BY COMPUTING WE GET IRR = 30.94%
BASED ON IRR WE SHOUL CHOOSE B
4]ON THE WHOLE WE SHOULD TAKE NPV AS THE CTITERIA TO JUDGE WHICH PROJECT WE SHOULD ACCEPT. NPV IS THE SUPREME CRITERIAN TO JUDGE BETWEEN TWO MUTUALLY EXCLUSIVE PROJECTS . WE SHOULD ACCEPT PROJECT-A