Question

Consider the following two mutually exclusive projects: Year 0 -NM Cash Flow (A) Cash Flow (B) $422,000 -$38,500 45,500 20,100 60,500 13,600 77,500 17,100 537,000 13,900 The required return on these investments is 13 percent. a. What is the payback period for each project? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) b. What is the NPV for each project? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) c. What is the IRR for each project? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) d. What is the profitability index for each project? (Do not round intermediate calculations and round your answers to 3 decimal places, e.g., 32.161.) e. Based on your answers in (a) through (d), which project will you finally choose? years years Project A Project B Project A Project B c. Project A Project B Project A Project B

Answer 1

a.Cash flow (A)

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

                             = 3 years + ($422,000 - $203,500)/ $537,000

                             = 3 years +$218,500/ $537,000

                            = 3 years + 0.41

                            = 3.41 years.

Cash flow (B)

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

                            = 2 years + ($38,500 - $33,700)/ $13,600

                           = 2 years + $4,800/ $13,600

                           = 2 years + 0.35

                           = 2.35 years

b. Cash flow (A)

Net present value can be calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$422,000. Indicate the initial cash flow by 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 NPV button and enter the required return of 13%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The net present value is $48,709.41.   

Cash flow (B)

Net present value can be calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$38,500. Indicate the initial cash flow by 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 NPV button and enter the required return of 13%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The net present value is $10,314.69.  

c. Cash flow (A)

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

• Press the CF button.
• CF0= It is -$422,000. 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 button and enter the interest rate to get the IRR of the project.

The IRR is 16.68%.

Cash flow (B)

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

• Press the CF button.
• CF0= It is -$38,500. 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 button and enter the interest rate to get the IRR of the project.

The IRR is 26.13%.

d.Profitability index is calculated using the below formula:

Profitability Index= NPV + Initial investment/ Initial investment

Cash flow (A)

Profitability Index= $48,709.41 + $422,000 / $422,000

                                   = $470,709.41/ $422,000

                                   = 1.1154.

Cash flow (B)

Profitability Index= $10,314.69 + $38,500/ $38,500

                                   = $48,814.69/ $38,500

                                   = 1.2679.

e.Cash flow (A) should be chosen since it has the highest net present value.

In case of any query, kindly comment on the solution.