Question

6. Comparing Investment Criteria: Consider the following two mutually exclusive projects Year Cash Flow (A)Cash Flow (B) 0 $40,000 60,000 1 19,000 2 25,000 3 18,000 4 6,000 270,000 14,000 17,000 24,000 Whichever project you choose, if any, you require a 15 percent return on your investment. a. If you apply the payback criterion, which investment will you choose? Why? b. If you apply the discounted payback criterion, which investment will you ch oose? Why? c. If you apply the NPV criterion, which investment will you choose? Why? d. If you apply the IRR criterion, which investment will you choose? Why? e. If you apply the profitability index criterion, which investment will you choose? Why? f. Based on your answers in (a) through (e), which project will you finally choose? Why?

Answer 1

(a), (b) and (c)

(d)

TIME Year 0 Year 1 Year 2 Year 3 Year 4 2 Discount Rate (in %) 3 PV Factor @ 15 % 15 0.870 0.756 0.658 0.572 5 Project A 6 Annual Cash Flows (ACFs) 7 PV of ACFs 8 Project NPV 9 Payback Period 10 Discounted Payback Period 19000 25000 18000 6000 -40000.00 16521.74 18903.59 11835.29 3430.52 10691.14 1.84 2.39 12 Project B 13 Annual Cash Flows (ACFs) 14 PV of ACFs 15 Project NPV 16 Payback Period 17 Discounted Payback Period 14000 17000 24000 270000 -60000 12173.91 12854.44 15780.39 154373.4 135182.1 3.02 3.12 TIME Year 0 Year 1 Year 2 Year 3 Year 4 2 Discount Rate (in %) 3 | PV Factor @ 15 % 15 (1/(1+($B$2/100) D3/(1H$8$2/100)) E31(SB$2/100 F3/1H$B$2/100)) 5 Project A 6 Annual Cash Flows (ACFs) 7 PV of ACFs 8 Project NPV 9 Payback Period 10 Discounted Payback Period 40000 19000 25000 18000 6000 (D3 D6) F3*F6) (G3 G6) SUM(C7:G7) 2 (-C7-D7-E7)/F7) 12 Project B 13 Annual Cash Flows (ACFs) 14 PV of ACFs 15 Project NPV 16 Payback Period 17 Discounted Payback Period 14000 17000 24000 270000 (C13 C3) (D13 D3) (E13*E3) F13*F3) G13*G3) -SUMIC14:614) -3 ((-C13-D13-E13-F13)/G13) -3+(-C14-D14-E14-F14)/G14) 5 Project A 6 Annual Cash Flows (ACFs) 7 PV Factor @ IRR 8 PV of ACFs 9 IRR (in %) Year O Year 1 Year 2 Year 3 Year 4 6000 0.356 40000.00 14671.66 14907.04 8287992133.31 40000 19000 25000 18000 1 0.772 0.596 0.460 29.50 14 Project B 15 Annual Cash Flows (ACFs 16 PV Factor IRR 17 PV of ACFs 18 IRR (in %) Year 0 Year 1 Year 2 Year 3 Year 4 -60000 24000 270000 0.145 60000 8643.467 6479.908 5647.954 39228.67 14000 17000 1 0.617 0.381 0.235 61.97

As both the payback and discounted payback periods of Project A is lesser than that of Project B's, the former should be selected under the Payback and Discounted Payback Criterion.Under the NPV criterion Project B should be selected as Project B has greater positive NPV as compared to Project A's NPV. Similarly, Project B should be selected under the IRR criterion as the same is greater for project B as compared to project A.

NOTE: Please raise separate queries for solutions to the remaining two sub-parts as one query is restricted to the solution of only one question with a maximum of four sub-parts.