Question

Consider the following cash flows for two mutually exclusive capital investment projects. The required rate of return is 12%. Use this information for the next 5 questions.

Year Project A Cash Flow Project B Cash Flow
0 -$32,400 -$14,400
1 9,600 4,200
2 9,600 4,200
3 9,600 4,200
4 8,400 3,600
5 8,400 3,600
6 6,000 3,600

1. What is the IRR of project A?

a) 18.69% c) 10.05% e) 16.58%
b) 12.97% d) 16.32%

2. What is the payback period of project A?

a) 3.5 years c) 4.57 years e) 3.8 years
b) 3.43 years d) 3.57 years

3. What is the profitability index of project A?

a) 1.128 d) 1.09
b) 1.045 e) 1.117
c) .98

4. Calculate the net present value of project B. a) $1,842 d) $1,415
b) $3,802 e) $2,223 c) $3,471

Answer 1

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

• Press the CF button.
• CF0= It is -$32,400. 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 16.32%.

Hence, the answer is option d.

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

                                   = 3 years + ($32,400 - $28,800)/$8,400

                                   = 3 years + $3,600)/$8,400

                                   = 3 years + 0.4286

                                   = 3.4286 years   3.43 years

Hence, the answer is option b.

3. Profitability index is calculated using the below formula:

Profitability Index= NPV + Initial investment/ Initial investment

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

• Press the CF button.
• CF0= -$32,400. 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 NPV button and enter the required rate of return of 12%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The net present value of cash flows is $3,802.1043

Profitability Index= $3,802.10 + $32,400/ $32,400

                                   = $36,802.10

                                   = 1.1173.

Hence, the answer is option e.

4. Net present value is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$14,400. 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 NPV button and enter the required rate of return of 12%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The net present value of cash flows is $1,842.1651   $1,842.17.

Hence, the answer is option a.

In case of any query, kindly comment on the solution