Question

X-treme Vitamin Company is considering two investments, both of which cost $44,000. The cash flows are as follows:

Year	Project A			Project B
1	$	46,000		$	44,000
2		17,000			18,000
3		13,000			15,000

Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a-1. Calculate the payback period for Project A and Project B. (Round your answers to 2 decimal places.)
  

a-2. Which of the two projects should be chosen based on the payback method?
  

• Project A

• Project B

b-1. Calculate the net present value for Project A and Project B. Assume a cost of capital of 8 percent. (Do not round intermediate calculations and round your final answers to 2 decimal places.)
  

b-2. Which of the two projects should be chosen based on the net present value method?
  

• Project B

• Project A

c. Should a firm normally have more confidence in the payback method or the net present value method?
  

• Payback method

• Net present value method

Answer 1

Present Value = Future value/ ((1+r)^t)
where r is the interest rate that is 8% and t is the time period in years.
Net present value (NPV) = initial investment + sum of present values of future cash flows.
PROJECT A
Year	0	1	2	3
cash flow	-44000	46000	17000	13000
present value		42592.59	14574.76	10319.82
NPV	23487.17
Since 46000 will be recovered in 1 year,
44000 will be recovered in .956 years.
The payback period for project A is .956 years.
PROJECT B
Year	0	1	2	3
cash flow	-44000	44000	18000	15000
present value		40740.74	15432.1	11907.48
NPV	24080.32
44000 will be recovered in 1 year.
The payback period for project B is 1 year.
a-1)
The payback period for project A is .96 years.
The payback period for project B is 1 year.
a-2) Project A should be chosen based on the payback period method
because the project recovers the initial investment faster.
b-1) The NPV of project A is $23487.17.
The NPV of project B is $24080.32.
b-2) Project B should be chosen based on the net present value method
because project B has a higher net present value.
c) A firm should have more confidence in the net present value (NPV)
method because it accounts for the time value of money.
The payback method does not take into account the time value of money
and it does not consider cash flows after the payback period.