Question

All techniques—Decision among mutually exclusive investments   

Pound Industries is attempting to select the best of three mutually exclusive projects. The initial investment and​ after-tax cash inflows associated with these projects are shown in the following table

Cash flows Initial investment (CF) Cash inflows (CF), t=1to 5 Project A $150,000 $45.000 Project B $170,000 $56.500 Project C $190,000 $58.000

a.  Calculate the payback period for each project.

b.  Calculate the net present value​ (NPV) of each​ project, assuming that the firm has a cost of capital equal to 12​%.

c.  Calculate the internal rate of return​ (IRR) for each project.

d.  Indicate which project you would recommend.

Answer 1

a.Payback period= full years until recovery + unrecovered cost at the start of the year/cash flow during the year

Project A

Payback period= 3 years + 15,000/ 45,000

                              = 3 years + 0.33

                              = 3.33 years.

Project B

Payback period= 3 years + 500/ 56,500

                              = 3 years + 0.0088.

                              = 3.0088 years.

Project C

Payback period= 3 years + 16,000/ 58,000

                              = 3 years + 0.28

                              = 3.28years.

b.Project A

Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$150,000 It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the cost of capital of 12%.
• Press the down arrow and CPT buttons to get the net present value.

Net present value of cash flows at 10% cost of capital is $12,214.93.

Project B

Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$170,00 It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the cost of capital of 12%.
• Press the down arrow and CPT buttons to get the net present value.

Net present value of cash flows at 10% cost of capital is $33,669.86.

Project C

Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$190,00 It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the cost of capital of 12%.
• Press the down arrow and CPT buttons to get the net present value.

Net present value of cash flows at 10% cost of capital is $19,077.02.

c.Project A

Internal rate of return is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$150,000.It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of the project A is 15.24%.

Project B

Internal rate of return is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$170,000.It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of the project B is19.72%.

Project C

Internal rate of return is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$170,000.It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of the project C is 15.98%.

d.I would recommend project B since it has the highest net present value.

In case of any further queries, kindly comment on the solution.