Question

Qu. Question P9 (9 Points) All techniques, conflicting rankings. Nicholson Roofing Materials, Inc. is considering two mutually exclusive projects. Project A has an initial investment of $75,000 and Project B has an initial investment of $30,000. The company's board of directors has set a 2-year payback requirement and has set its cost of capital at 10%. The cash inflows associated with the two projects are shown in the following table: Cash inflows ($) Year Project A Project B 20,000 20,000 25,000 12,500 10,000 5,000 40,000 10,000 AWN- a. Fill out the Table and Circle the Project you would recommend based on the Profit Measure. Show all work. Profit Measure Project A Project B Recommend Payback A or B IRR A or B NPV A or B Profit Index A or B b. Based on all the profit measures, which project would you recommend and why? (Please answer in one or two sentences)

Answer 1

	Calculation of profit measures for Project A
			For Payback period	For IRR	For NPV
	Year	Cashflows ($)	Cumulative cashflows	Discounting factor @ 9.24995%	PV of cashflows	Discounting factor @ 10%	PV of cashflows
	0	-75000	-75000	1	-75000.00	1	-75000.00
	1	20000	-55000	0.915332227	18306.64	0.909090909	18181.82
	2	25000	-30000	0.837833085	20945.83	0.826446281	20661.16
	3	10000	-20000	0.766895624	7668.96	0.751314801	7513.15
	4	40000	20000	0.701964279	28078.57	0.683013455	27320.54
			NPV		0.00		-1323.34
A1)	Pay-off period= A+ (B/C)
	where,
	A= last period number with negative cumulative cashflows
	B= absolute value of cumulative net cashflow at the end of period A
	C= total cash inflow during the period following period A
	Pay-off period= 3+(20000/40000)
			3.5years
A2)	We know that IRR is the rate at which NPV of the project is 0. By trial and error method we guessed the IRR of project A to be 9.24995%. So the IRR is 9.24995% as the NPV is zero at that rate (see the table above).
A3)	We know NPV of the project is equal to the present value of cashflows discounted at the required rate of return. NPV of project A is ($1323.34)- Refer table for details
A4)	Profitability index= (Initial investment+NPV)/Initial investment
		(75000-1323.34)/75000
			0.98
	Calculation of profit measures for Project B
			For Payback period	For IRR	For NPV
	Year	Cashflows ($)	Cumulative cashflows	Discounting factor @ 26.49266%	PV of cashflows	Discounting factor @ 10%	PV of cashflows
	0	-30000	-30000	1	-30000.00	1	-30000.00
	1	20000	-10000	0.790559705	15811.19	0.909090909	18181.82
	2	12500	2500	0.624984647	7812.31	0.826446281	10330.58
	3	5000	7500	0.494087679	2470.44	0.751314801	3756.57
	4	10000	17500	0.39060581	3906.06	0.683013455	6830.13
			NPV		0.00		9099.11
B1)	Pay-off period= A+ (B/C)
	where,
	A= last period number with negative cumulative cashflows
	B= absolute value of cumulative net cashflow at the end of period A
	C= total cash inflow during the period following period A
	Pay-off period= 1+(10000/12500)
			1.8 years
B2)	We know that IRR is the rate at which NPV of the project is 0. By trial and error method we guessed the IRR of project B to be 26.49266%. So the IRR is 26.49266% as the NPV is zero at that rate (see the table above).
B3)	We know NPV of the project is equal to the present value of cashflows discounted at the required rate of return. NPV of project A is $9099.11- Refer table for details
B4)	Profitability index= (Initial investment+NPV)/Initial investment
		(30000+9099.11)/30000
			1.30
	Therefore to summarise,
a)	Profit measure	Project A	Project B	Recommendation
	Payback	3.5 years	1.8 years	B
	IRR	9.24995%	26.49266%	B
	NPV	($1,323.34)	$9,099.11	B
	Profit Index	0.98	1.3	B
b)	Based on all the profit measures Project B is recommended as it has surpassed A in all respect. Further its payback period is also within the range of 2 years as decided by the management.