Consider the following two mutually exclusive projects: Year Cash Flow (A) Cash
ID: 2782298 • Letter: C
Question
Consider the following two mutually exclusive projects: Year Cash Flow (A) Cash Flow (B) 0 –$ 360,000 –$ 45,000 1 35,000 23,000 2 55,000 21,000 3 55,000 18,500 4 430,000 13,600 Whichever project you choose, if any, you require a 14 percent return on your investment. a-1 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.) Payback period Project A years Project B years a-2 If you apply the payback criterion, which investment will you choose? Project A Project B b-1 What is the discounted payback period for each project? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) Discounted payback period Project A years Project B years b-2 If you apply the discounted payback criterion, which investment will you choose? Project A Project B c-1 What is the NPV for each project? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) NPV Project A $ Project B $ c-2 If you apply the NPV criterion, which investment will you choose? Project B Project A d-1 What is the IRR for each project? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) IRR Project A % Project B % d-2 If you apply the IRR criterion, which investment will you choose? Project A Project B e-1 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.) Profitability index Project A Project B e-2 If you apply the profitability index criterion, which investment will you choose? Project A Project B f. Based on your answers in (a) through (e), which project will you finally choose?
Explanation / Answer
Cash Flows for Project A: $-360,000; 35,000; 55,000; 55,000; 430,000
Cash Flows for Project B: $-45,000; 23,000; 21,000; 18,500; 13,600
1.) Payback Period for Project A = 3 + (360,000 -145,000)/430,000 = 3 + 0.50 =3.50 years
Payback Period for Project B = 2 + (45,000 - 44,000)/18,500 = 2 + 0.054 =2.054 years
As per Payback method, Project B should be selected
2.) Return Required =14%
Discounted Cash Flows for Project A: $-360,000; 30,702; 42,321; 37,123; 254,595
Discounted Cash Flows for Project B: $-45,000; 20,175; 16,159; 12,487; 8,052
Discounted Payback for Project A = 3 + (360,000-110,146)/254,595 = 3 + 0.98 =3.98 years
Discounted Payback for Project B = 2 + (45,000-36,334)/12,487 = 2 + 0.69 =2.69 years
As per Dicsounted Payback method, Project B should be selected
3.) NPV for Project A=$-360,000 + 30,702 + 42,321 + 37,123 + 254,595 =$4,740.42
NPV for Project B= $-45,000 + 20,175 + 16,159 + 12,487 + 8,052 = $11,873.52
Project B should be selected because it has the higher NPV
4.) IRR is the rate at which NPV=0
For Project A,
360,000 = 35,000/(1+IRR) + 55,000/(1+IRR)2 + 55,000/(1+IRR)3 + 430,000/(1+IRR)4
360 = 35/(1+IRR) + 55/(1+IRR)2 + 55/(1+IRR)3 + 430/(1+IRR)4
Solving using Trial and Error method for IRR, we get,
IRR = 0.1444
Hence, IRR for Project A =14.44%
For Project B,
45,000 = 23,000/(1+IRR) + 21,000/(1+IRR)2 + 18,500/(1+IRR)3 + 13,600/(1+IRR)4
45 = 23/(1+IRR) + 21/(1+IRR)2 + 18.5/(1+IRR)3 + 13.6/(1+IRR)4
Solving using Trial and Error method for IRR, we get,
IRR = 0.2754
Hence, IRR for Project B =27.54%
Project B should be selected because it has the higher IRR