Question

Consider the following two mutually exclusive projects:

Year Cash Flow (A) $170,000 30,000 20,000 15,000 380,000 Cash Flow (B) $18,000 15,000 10,000 3,000 3,000

Whichever project you choose, if any, you require a 10% return on your investment.

1. If you apply the payback criterion, which investment will you choose?
2. If you apply the NPV criterion, which investment will you choose?
3. If you apply the IRR criterion, which investment will you choose? (Better help with Excel)
4. Based on your answers (a) through (c), which project will you finally choose?

Answer 1

Present Value = Future value/ ((1+r)^t)
where r is the interest rate that is 10% and t is the time period in years.
Net present value (NPV) = initial investment + sum of present values of future cash flows.
Internal rate of return (IRR) is the interest rate for which the NPV is zero.
Use the financial formulas in excel to calculate the IRR.
PROJECT A
Year	0	1	2	3	4
cash flow	-170000	30000	20000	15000	380000
present value		27272.73	16528.93	11269.72	259545.1
NPV	144616.5
Payback period	3.829
IRR	31%
PROJECT B
Year	0	1	2	3	4
cash flow	-18000	15000	10000	3000	3000
present value		13636.36	8264.463	2253.944	2049.04
NPV	8203.811
Payback period	1.3
IRR	38%
a) If you apply the payback criterion, you would choose project B because
it has a smaller payback period of 1.3 years compared to project A that has a
payback period of 3.829 years.
b) If you apply the NPV criterion, you would choose project A because it has a
higher NPV.
c) If you apply the IRR criterion, you would choose project B because it has a higher IRR
compared to the IRR of project A.
d) Based on the answers from a through c, you would choose project B over project A because
project B has a smaller payback period and a higher IRR.