Consider the following two mutually exclusive projects: Year Cash Flow (A) Cash
ID: 2770196 • Letter: C
Question
Consider the following two mutually exclusive projects: Year Cash Flow (A) Cash Flow (B) 0 –$419,000 –$37,000 1 47,000 19,800 2 59,000 13,900 3 76,000 15,600 4 534,000 12,400 The required return on these investments is 11 percent. Required: (a) What is the payback period for each project? (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).) Payback period Project A years Project B years (b) What is the NPV for each project? (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).) Net present value Project A $ Project B $ (c) What is the IRR for each project? (Do not round intermediate calculations. Enter your answers as a percentage rounded to 2 decimal places (e.g., 32.16).) Internal rate of return Project A % Project B % (d) What is the profitability index for each project? (Do not round intermediate calculations. Round your answers to 3 decimal places (e.g., 32.161).) Profitability index Project A Project B (e) Based on your answers in (a) through (d), which project will you finally choose?
Explanation / Answer
Initial Investment Required
Payback period
The payback period is the time required for the amount invested in an asset to be repaid by the net cash outflow generated by the asset. It is a simple way to evaluate the risk associated with a proposed project.
PV of cash flow = cashflow/ ( 1+i)^n
where i = 11% and n is the number of period
On the basis of above the Project A should choosen as its NPV is nearly 7 times than that of project B.
Year Cash flow project A PV at 11% Cash flow project B PV at 11% 0 (419,000) (419,000) (37,000) (37,000.00) 1 47,000 42,342 19,800 17,837.84 2 59,000 47,886 13,900 11,281.55 3 76,000 55,571 15,600 11,406.59 4 534,000 351,762 12,400 8,168.26 NPV 78,561 11,694 IRR 17% 26% Pay back period years 3.44 2.27 Present value of future cashflows 497,561 48,694 Initial investment 419,000 37,000 Profitability index 1.19 1.32