Question

Here are the expected cash flows for three projects: Project Year: IU 0 - 5,700 - 1,700 - 5,700 Cash Flows (dollars) 1 2 3 + 1,175 + 1,175 + 3,350 0 + 1,700 + 2,350 + 1,175 + 1,175 + 3,350 4 0 + 3,350 + 5,350 a. What is the payback period on each of the projects? b. If you use the payback rule with a cutoff period of 2 years, which projects will you accept? c. If you use a cutoff period of 3 years, which projects will you accept? d-1. If the opportunity cost of capital is 12%, calculate the NPV for projects A, B, and C. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to 2 decimal places.) d-2. Which projects have positive NPVs? e. "Payback gives too much weight to cash flows that occur after the cutoff date." True or false? Project A Years Project B Years Project C Years a. Payback period b. If you use the payback rule with a cutoff period of 2 years, which projects will you accept? c. If you use a cutoff period of 3 years, which projects will you accept? d-1. If the opportunity cost of capital is 12%, calculate the NPV for projects A, B, and C. d-2. Which projects have positive NPVs? e. "Payback gives too much weight to cash flows that occur after the cutoff date." True or false?

Answer 1

Sr.No	Particulars	'A'	'B'	'C'
a.	Payback period	3 years	2 years	3 years
b.	If you use the payback rule with a cutoff period of 2 years, which project will you accept?	Project B
c.	If you use a cutoff period of 3 years, which project will you accept?	Project A, B ,C
d.1.	If the opportunity cost of capital is 12%, calculate NPV for projects A,B & C	-1,329.73	3456.90	2070.30
d.2.	Which project has positive NPV's?	Project B & C
e.	Payback gives too much weight to cash flows that occurs after the cut off date, True or False?	False

Working notes:

a. The year in which the cash outflow is recovered by the proposed project will be the payback period of such project. Therefore payback period of projects A, B & C are 3 years, 2 years and 3 years respectively.

Project A Outflow - 5700			Project B Outflow - 1700			Project C Outflow - 5700
Year	Cash inflow	Cumulative Cash inflow	Year	Cash inflow	Cumulative Cash inflow	Year	Cash inflow	Cumulative Cash inflow
1	1175	1175	1	0	0	1	1175	1175
2	1175	2350	2	1700	1700	2	1175	2350
3	3350	5700	3	2350	4050	3	3350	5700
4	0		4	3350	7400	4	5350	11050

d.1.

Calculation of NPV:-

Project A

= -5700 + $\frac{1175}{1.12}$ + $\frac{1175}{1.12^2}$ + $\frac{3350}{1.12^3}$ = -1329.73

Project B

= - 1700 +  $\frac{1700}{1.12^2}$ +  $\frac{2350}{1.12^3}$ +  $\frac{3350}{1.12^4}$ = 3456.90

Project C

= -5700 + $\frac{1175}{1.12}$ + $\frac{1175}{1.12^2}$ + $\frac{3350}{1.12^3}$ + $\frac{5350}{1.12^4}$ = 2070.30