Question

Important: Show your solutions! QUESTION 1: Consider the following two projects: Year Cash Flow (A) Cash Flow (B) -$364,000 -$52,000 25,000 46,000 68,000 22,000 68,000 21,500 458,000 17,500 Whichever project you choose, if any, you require a return of 11 percent on your investment. 1) Suppose these two projects are independent. Which project(s) should you accept based on: a. The Payback rule? Explain. (1096) b. The Profitability Index rule? Explain. (10%) c. The IRR rule? Explain. (10%) d. The NPV rule? Explain. (1096) 2) Suppose these two projects are mutually exclusive. Which project should you accept? Explain. (10%)

Answer 1

Multiple question are not allowed under 1 post. I will answer Q1.

a)	Payback
Year	Cash Flow (A)	Cumulative Cash Flow(A)	Cash Flow (B)	Cumulative Cash Flow(B)
0	-364000	-364000	-52000	-52000
1	46000	-318000	25000	-27000
2	68000	-250000	22000	-5000
3	68000	-182000	21500	16500
4	458000	276000	17500	34000
Payback Period Project A = 3 + 182000/458000	3.40	years
Payback Period Project A = 2 + 5000/21500	2.23	years
b)
Profitability Index = Present Value of Future Cash Flows ÷ Initial Investment in the Project.
Year	Cash Flow (A)	PV @ 11%	Present Value Cash Flow A	Cash Flow (B)	PV @ 11%	Present Value Cash Flow B
1	46000	0.9009	$     41,441.44	25000	0.9009	$  22,522.52
2	68000	0.8116	$     55,190.33	22000	0.8116	$  17,855.69
3	68000	0.7312	$     49,721.01	21500	0.7312	$  15,720.61
4	458000	0.6587	$   301,698.79	17500	0.6587	$  11,527.79
		Total	$   448,051.57			$  67,626.62
PI (A) = $448051.57/364000	1.23
PI (B) = $67,626.62/52000	1.30
c)
Year	Cash Flow (A)	Cash Flow (B)
0	-364000	-52000
1	46000	25000
2	68000	22000
3	68000	21500
4	458000	17500
IRR	18.14%	25.29%
d)
Year	Cash Flow (A)	PV @ 11%	Present Value Cash Flow A	Cash Flow (B)	PV @ 11%	Present Value Cash Flow B
0	-364000	1.0000	$ (364,000.00)	-52000	1.0000	$ (52,000.00)
1	46000	0.9009	$     41,441.44	25000	0.9009	$  22,522.52
2	68000	0.8116	$     55,190.33	22000	0.8116	$  17,855.69
3	68000	0.7312	$     49,721.01	21500	0.7312	$  15,720.61
4	458000	0.6587	$   301,698.79	17500	0.6587	$  11,527.79
		NPV	$     84,051.57			$  15,626.62
	Project A	Project B		Accepted
Payback	3.40	2.23	Years	Project B
Profitabiity Index	1.23	1.30		Project B
IRR	18.14%	25.29%		Project B
NPV	$             84,051.57	$               15,626.62		Project A
2) In case of mutually exclusive projects, the project with highest net present value or the highest IRR or the lowest payback period is preferred and a decision to invest in that winning project exclused all other projects from consideration even if they individually have positive NPV or higher IRR than hurdle rate or shorter payback period than the reference period.
In Such situation Project A would be selected since its NPV is higher than project B.