ABC Inc. is considering two independent projects . Both projects have an initial
ID: 2797520 • Letter: A
Question
ABC Inc. is considering two independent projects . Both projects have an initial cost of $38,000. The cash inflows of Project AA are $6,000, $10,000, $16,000 and $25,000 respectively over the next four years. The cash inflows of Project BB are $18,000, $16,000, $10,000 and $6,000 over the next four year s, respectively. The required yearly rates of return of both projects are 8%.
(a) Calculate the net present value of the two projects. (4 marks)
(b) Calculate the payback period of the two projects. (4 marks)
(c) What is the investment decision based on the net present value? Explain. (2 marks)
(d) What is the investment decision based on the payback period if the cutoff period for any project is 3 years ? Explain. (2 marks)
(e) What is the investment decision based on the IRR criterion ? Explain. (2 marks)
Explanation / Answer
NPV of AA=-38000+6000/1.08+10000/1.08^2+16000/1.08^3+25000/1.08^4=7206.006
NPV of BB=-38000+18000/1.08+16000/1.08^2+10000/1.08^3+6000/1.08^4=4732.589
IRR of AA:
0=-38000+6000/(1+IRR)+10000/(1+IRR)^2+16000/(1+IRR)^3+25000/(1+IRR)^4
IRR=14.5742%
IRR of BB:
0=-38000+18000/(1+IRR)+16000/(1+IRR)^2+10000/(1+IRR)^3+6000/(1+IRR)^4
IRR=14.6196%
Payback of AA=3+6000/25000=3.24 years
Payback of BB=2+4000/10000=2.4 years
As per IRR criterion, we accept projects whose IRR is more than required return of 8%. Hence, Accept both Projects
As per NPV criterion, we accept projects whose NPV is more than 0. Hence, Accept both Projects
As per payback criterion, we accept projects whose payback is less than cutiff date of 3 years. Hence, Accept Project BB