Question

SECTION II (Answer all questions in this section -50pt.) Consider following the streams of cash flows for projects A and B Yr 0 - 50, 000 - 300, 000 Yr 1 $ 25, 000 120, 000 Yr 2 $ 25,000 130,000 Yr 3 $ 25,000 A: B: 140,000 Calculate the Payback Periods for both Projects A and B. If your firm expects to recover its investment in such projects within 2 years, will you accept either project? Give reason (10 pt) la. lb. Calculate the Net Present Value and the Profitability Index for both Projects if their required return is 12 %. Would you accept the projects under either criterion? Why or why not? (18 pt)

Answer 1

1.
a)
Payback period (Project A) = 2 years
Accept the Project A.

Payback period (Project B) = 2 years + (50,000/140,000)
= 2.3571 years

Project B should not be accepted.

b)

A C D E F G I J B Project A: Year H Project B: Year Cash flows -50000 25000 25000 25000 Present value -300000 107142.86 PV factor @12% 1 0.8929 0.7972 0.7118 NPV Present value -50000 22321.43 19929.85 17794.51 10045.78 Cash flows PV factor @12% -300000 1 120000 0.8929 130000 0.7972 140000 0.7118 NPV 103635.20 99649.23 10427.30 NPV = $10,045.78 (approx) NPV = $10,427.30 (approx) NPV is positive, so the project should be accepted. NPV is positive, so the project should be accepted. Profitability index = (NPV + Initial investment) / Initial investme = ($10,045.7817 + $50000) / 50,000 = 1.2009 Profitability index = (NPV + Initial investment) / Initial investment = ($10,427.2959 + $300,000) / $300,000 = 1.0348 15

Excel formula:

E F G B C D Project A: Year Cash flows PV factor @12% -50000 =1/(1.12)^B3 25000 =1/(1.12)^B4 25000 =1/(1.12)^B5 25000 =1/(1.12)^B6 NPV Present value =C3*D3 =C4*D4 =C5*D5 =C6*D6 =SUM(E3:E6) H I J Project B: Year Cash flows PV factor @12% -300000 =1/(1.12)^H3 120000 =1/(1.12)^H4 130000 =1/(1.12)^H5 140000 =1/(1.12)^H6 NPV Present value 1=13*]3 =14*J4 =15*J5 =16*J6 =SUM(K3:66) WN NPV = $10,045.78 (approx) NPV = $10,427.30 (approx) NPV is pos NPV is positive, so the project should be accepted. 13 Profitability index = (NPV + Initial investment) / Initial ini = ($10,045.7817 + $50000) / 50,000 = 1.2009 Profitability index = (NPV + Initial investment) / Initial investment =($10,427 = 1.0348

2)

A B 2) Year Cash flows 0 -50000 1 25000 2 25000 3 25000 IRR 23.38% IRR > Cost of capital. Project A should be accepted. 00

Excel formula:

B 2) Year Cash flows -50000 1 25000 25000 3 25000 IRR =IRR(C19:C22) IRR > Cost of capital. Project A should be accepted.