Question

Nicholson Roofing​ Materials, Inc., is considering two mutually exclusive​ projects, each with an initial investment of

​$100000.

The​ company's board of directors has set a​ 4-year payback requirement and has set its cost of capital at

12​%.

The cash inflows associated with the two projects are shown in the following​ table:

YR Project A Project B

1 30000 85000

2 30000 50000

3 30000 10000

4 30000 10000

5 30000 10000

6 30000 10000

.a. Calculate the payback period for each project. Rank the projects by payback period.

b.  Calculate the NPV of each project. Rank the project by NPV.

c.  Calculate the IRR of each project. Rank the project by IRR.

d.  Make a recommendation.

Answer 1

a.Project A

Payback period=full years until recovery + unrecovered cost at the start of the year/cash flow during the year

                    = 3 years + ($100,000 - $90,000)/ $30,000

                    = 3 years + $10,000/ $30,000

                   = 3 years + 0.33

                   = 3.33 years

Project B

Payback period=full years until recovery + unrecovered cost at the start of the year/cash flow during the year

                              = 1 year + ($100,000 - $85,000)/ $50,000

                              = 1 year + 15,000/ 50,000

                              = 1 year + 0.30

                              = 1.30 years.

Ranking the projects by payback method:

1.Project B

2. Project A

b. Project A

Net present value can be calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$100,000. Indicate the initial cash flow by a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the cost of capital of 12%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The net present value is $23,342.22.

Project B

Net present value can be calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$100,000. Indicate the initial cash flow by a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the cost of capital of 12%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The net present value is $39,966.11.

Ranking the projects by NPV:

1.Project B

2. Project A

c. Project A

Internal rate of return can be calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= It is -$100,000 here. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR button and enter the interest rate to get the IRR of the project.

The IRR is 19.91%.

Project B

Internal rate of return can be calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= It is -$100,000 here. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR button and enter the interest rate to get the IRR of the project.

The IRR is 36.14%.

Ranking the projects by IRR:

1.Project B

2. Project A

d.I will recommend to accept Project B since it has the highest net present value.

In case of any query, kindly comment on the solution.