Question

1. Will is trying to select the best investment from among 3 alternatives. Each alternative involves an initial outlay of 100,000$. Their cash flows returns for each project are as follows (in $): year project C project A 10,000 20,000 30,000 40,000 50,000 project B 50,000 40,000 30,000 min 45,000 55,000 60,000 a) Evaluate and rank each alternative based on the payback period? What are the general problems associated with using this method? b) Evaluate and rank each alternative based on Net Present Value (use a 10% discounted rate). What are the problems using the NPV? c) Was there any decision conflicts between you got in a) and in b)? If there is a discrepancy then which method would you use and why?

Answer 1

Solution: Project A Project B Project C Cash flow Cumulative Cash flow Cumulative Cash flow Cumulative Year -100000 -100000 -100000 -100000 -100000 -100000 -90000 10000 50000 -50000 -100000 20000 -70000 40000 -10000 -100000 -40000 30000 30000 20000 45000 -55000 40000 20000 55000 50000 60000 60000 50000 20000 Payback period Project A Project B Project C Rank 4.00 Years 2+(10000/30000) 2.33 Years 4.00 Years Problems: Payback period ignores time value of money and cash flow after payback period. Part b: Project A Project B Project C PV factor working cash flow PV cash flow PV cash flow Pv PV factor at 10% Year g=a*f -100000 -100000.00 c=a*b e=a*d a 1.00000 1/(1+0.1)^0 0.90909 1/(1+0.1)^1 0.82645 1/(1+0.1)^2 0.75131 1/(1+0.1)^3 0.68301 1/(1+0.1)^4 0.62092 1/(1+0.1)^5 -100000 -100000.00 -100000 -100000.00 0.00 50000 10000 9090.91 45454.55 20000 33057.85 0.00 16528.93 40000 30000 22539.44 30000 22539.44 45000 33809.17 40000 27320.54 0.00 55000 37565.74 37255.28 50000 31046.07 0.00 60000 6525.88 NPV NPV 1051.84 NPV 8630.19 Rank Problems: The only problem with NPV method is that it is difficult to estimate future cash flows and discount rate. Part c: Yes there is conflict between two methods and NPV should be ideal method to use at it removes the problem which are there in payback period