All techniques — Decision among mutually exclusive investments Pound Industries
ID: 2785629 • Letter: A
Question
All techniques—Decision among mutually exclusive investmentsPound Industries is attempting to select the best of three mutually exclusive projects. The initial investment and after-tax cash inflows associated with these projects are shown in the following table.
Cash flows
Project A
Project B
Project C
Initial investment (CF)
$90,000
$130,000
$130,000
tequals = 1 to 5
$30,000
$42,000
$42,500
a.Calculate the payback period for each project.
b.Calculate the net present value (NPV) of each project, assuming that the firm has a cost of capital equal to 9%.
c.Calculate the internal rate of return (IRR) for each project.
d.Indicate which project you would recommend.
Cash flows
Project A
Project B
Project C
Initial investment (CF)
$90,000
$130,000
$130,000
Cash inflows (CF),tequals = 1 to 5
$30,000
$42,000
$42,500
Explanation / Answer
Part A
Project A
In year 1 the company expects to revcover $30000 , that means initial investment yet to recover shall be (90000-30000)= $60000.
In year 2 the company expects to revcover $30000 , that means initial investment yet to recover shall be (60000-30000)= $30000.
In year 3 the compnay expects to recover $30000 , thereby recovering $30000 in third year.
Thereby payback for project A is 3 years.
Project B
In year 1 the company expects to recover $42000 , that means initial investment yet to recover shall be (130000-42000)= $88000
In year 2 the compnay expects to recover $42000 , that means initial investment yet to recover shall be (88000-42000)= 46000
In year 3 the compnay expects to recover $42000 ,that means initial investment yet to recover shall be (46000-42000)= 4000
In year 4 the compnay expects to recover $42000 , thereby recovering $4000 in ($4000/42000) 0.095 year.
Thereby payback for project B is 4.095 years.
Project C
In year 1 the company expects to recover $42500 , that means initial investment yet to recover shall be (130000-42500)= $87500
In year 2 the compnay expects to recover $42500 , that means initial investment yet to recover shall be (87500-42500)= $45000
In year 3 the compnay expects to recover $42500 ,that means initial investment yet to recover shall be (45000-42500= 2500
In year 4 the compnay expects to recover $42500 , thereby recovering $2500 in ($2500/42500) 0.00588 year.
Thereby payback for project C is 4.00588 years.
Part B
If MARR is 9%
Project A
Cash outflows at 0 year = ($90000)
Present value of cash inflows= $30000*0.917 + $30000*0.842 + $30000 * 0.772 + $30000 * 0.708 + $30000 * 0.650 = $ 116689.54
Net Present value = $$26,689.54
Project B
Cash outflows at 0 year = ($130000)
Present value of cash inflows= $42000*0.917 + $42000*0.842 + $42000 * 0.772 + $42000 * 0.708 + $42000 * 0.650 = $ 163335.63
Net Present value = $33365.63
Project C
Cash outflows at 0 year = ($130000)
Present value of cash inflows= $42500*0.917 + $42500*0.842 + $42500 * 0.772 + $42500 * 0.708 + $42500* 0.650 = $ 165310.18
Net Present value = $35310.18
Part C
Project A
At 15% discount rate , net present value comes out to be $10564.65
At 20% discount rate , net present value comes out to be $(281.64)
Thereby using interpolation IRR comes out to be 19.858%
Project B
At 15% discount rate , net present value comes out to be $10790.51
At 20% discount rate , net present value comes out to be $(4394.29)
Thereby using interpolation IRR comes out to be 18.455%
Project C
At 15% discount rate , net present value comes out to be $12466.59
At 20% discount rate , net present value comes out to be $(2898.98)
Thereby using interpolation IRR comes out to be 18.983%
Part d
Crieteria Project A Project B Project C Project to select Payback period 3 4.095 4.005 Project A NPV 26689 33365 35310 Project B IRR 19.458% 18.455% 18.983% Project A