Question

Two mutually exclusive projects have the following projected cash flows:

Year	Project A Cash flow	Project B Cash Flow
0	-$50,000	-$50,000
1	25,625	0
2	25,625	0
3	25,625	0
4	25,625	0
5	15,625	150,000

1. If the required rate of return on these projects is 20 percent, what are the NPVs of two projects? Which project should be better? If they are standalone projects, what is the choice?
2. If IRR_A = 40.36%, IRR_B = 24.57%, which project should be chosen?
3. What is the payback period for each project? If the cutoff period is 3 years, which project should be better?
4. What is the profitability index for each project?

Answer 1

Solution ) alculation of NPO of Project A and B =) Project A3 NPU= Present value of cash inflow - Present value y cash outflow Discount Rate (8) = 2044 On 0.20 So, we will calculate present value of lash inflowsy Present value of cash inflow) C2 che day on t he great things to detergent et les sys Here, C., C2, C3, Cygly are cash inflows in year 1, 2, 3, 4, 5. respectively Ye Discount rate or required rate of return PV = $25,625 25,625 - 25,625 - 25,625 + 15,625 (1+0.25" + (1+0.232" (10.937 [+ 0.234 * 1+0.235 = + 25,625 † 23,625 1 25.625 25, 12 + + 25,625 - 15,625 (1.25 (1.2 24715

= 21,354.1667 +17,795-1389 +14,829, 2824+ 12,357. 7353 t 6,279.33706 = = $ 72,61536604 $ 72,615.66 (approx) од Rio in an op-$ So, o oo so, it is cash outflow NPU- Present value of cash inflow - PV of cash outflow 5 $72,615, 66 - $50,000 = $ 22,615.66 Project B Cash outflow in year o= $50,000 lash inflow is only in year 5 eash inflow in year 5 = $150,000 Present value of cash inflow = c5 . (1+r)5 = $150,000 (170.235 $150,00 11.295

= $60,287.6358 = $60,281.64 (approx) NPV = Present value of cash! esent value of cash inflow present value of cash outflow = $ 60,281, 64- $ 50,000 z $10,281.64 Since NPV of project t is higher, it should be choosen on the basis of Nov.

I these projects are standalone projects, then both of these can be accepted as both of there has NPV greater than o,

IRRIO IRR of Project A (given) is 40.36% . IRR of Project B (given) is 24057% Project A should be choosen on the basis of IRR because it has higher IRR. use

Payback period : Project A =) Year (Cash inflow I cumulative cash inflow 25,625 25,625 2 25,625 51,250 3 25,625 25,625 5 15,625 So, we can see that initial investment of 50,009 is recovered before completing 2 years, Payback period is 7 year + (50,000 – 25,625) 25,625 = year to.951219 = 1. 951219 years Project B Payback period is 4 year + 1.50,000-0) 150,000 = = 4 years 4 0.333 4.333 year

In project B, there is no cash inflow upto 4 years so, cumulative cash flow upto 4 years is o we have to recover total 50,000 from cash flow generated in year 5, that is 150,000. Since cut-off period for each project is 3 years So, project A should be accepted as its payback period is less than cut off period while payback period of Project B is more than cut-off period So, Project B should not be accepted

Profitability Index = present, value of cash inflow Present valie of cash outflow Project P.I. - A $ 72,615.66 $50,000 = 1.45 23132 or 1.45 Copprox) Project B7 $ 60, 281.64 $50,000 - 1.2056328 on 1.21 Сафрон) Project A should be accepted as its P.Iz is higher