Consider the following two mutually exclusive projects: The required return on t
ID: 2733314 • Letter: C
Question
Consider the following two mutually exclusive projects:
The required return on these investments is 13 percent.
a. What is the payback period for each project? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
b. What is the NPV for each project? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
c. What is the IRR for each project? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
d. What is the profitability index for each project? (Do not round intermediate calculations and round your answers to 3 decimal places, e.g., 32.161.)
e. Based on your answers in (a) through (d), which project will you finally choose?
Year Cash Flow (A) Cash Flow (B) 0 –$ 427,000 –$ 41,000 1 43,000 20,600 2 63,000 13,100 3 80,000 19,600 4 542,000 16,400Explanation / Answer
a) Project A Project B Year Cash flow Commulative CF Year Cash flow Commulative CF 0 -427000 -427000 0 -41000 -41000 1 43000 -384000 1 20600 -20400 2 63000 -321000 2 13100 -7300 3 80000 -241000 3 19600 12300 4 542000 301000 4 16400 28700 16.59% Project A The payback period lies between year 3 and 4 payback period = 3 + 241000/542000 = 3 + 0.44 = 3.44 years Project B The payback period lies between year 2 and 3 payback period = 2 + 7300/19600 = 2 + 0.37 = 2.37 years b) NPV = CF1/ ( 1+i)1 + CF2 /(1+I)2 + CF3 / (1+i)3 + CF4 / (1+i)4 - Initial investment Project A NPV = 43000 / (1.13 )1 + 63000 /(1.13)2 + 80000 /(1.13)3 + 542000/(1.13)4 - 427000 = 43000 / 1.13 + 63000 / 1.2769 + 80000 / 1.4429 + 542000 / 1.6305 - 427000 = 38053.1+49338.24+55443.9+332413.4 - 427000 = 48248.61 Project B NPV = 20600 / (1.13 )1 + 13100 /(1.13)2 + 19600 /(1.13)3 + 16400/(1.13)4 - 41000 = 20600 / 1.13 + 13100 / 1.2769 + 19600 / 1.4429 + 16400 / 1.6305 - 41000 = 18230.09 + 10259.22 +13583.75 + 10058.26 - 41000 = 11131.33 c) IRR is when NPV = 0 Project A Let I = 17% NPV = 43000 / (1.17 )1 + 63000 /(1.17)2 + 80000 /(1.17)3 + 542000/(1.17)4 - 427000 = 43000 / 1.17 + 63000 / 1.3689 + 80000 / 1.6016 + 542000 / 1.8739 - 427000 = 36752.14+46022.35+49950.05+289236.4 - 427000 = 48248.61 = -5039 hence IRR = 16.5% Project B I = 26% NPV = 20600 / (1.26 )1 + 13100 /(1.26)2 + 19600 /(1.26)3 + 16400/(1.26)4 - 41000 = 20600 / 1.26 + 13100 / 1.5876 + 19600 / 2 + 16400 / 2.5205 - 41000 = 16349.21 + 8251.45 + 9800 + 6506.65 - 41000 = -92.70 hence IRR = 26% d) Profitability Index = 1 + NPV / Initial investment Project A PI = 1 + 48248.61 / 427000 = 1 + 0.11 0.1129944 = 1.11 Project B PI = 1 + 11131.31/41000 = 1 + 0.27 = 1.27 e) Project A B Payback period 3.44 2.37 NPV 48248.61 11131.31 IRR 16.50% 26% Profitability Index 1.11 1.27 Based on the above , Project B should be accepted as its paybackperiod is shorter , IRR and Profitability index is higher