Question

P10–24 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.
LG 2 LG 3
LG 4 LG 5
LG 6
LG 2 LG 3
LG 4 LG 5
LG 6
Project A Project B
Initial investment (CF0) $130,000 $85,000
Year (t) Cash inflows (CFt)
1 $25,000 $40,000
2 35,000 35,000
3 45,000 30,000
4 50,000 10,000
5 55,000 5,000
Cash flows Project A Project B Project C
Initial investment (CF0) $60,000 $100,000 $110,000
Cash inflows (CFt), t 5 1 to 5 20,000 31,500 32,500
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 13%.
c. Calculate the internal rate of return (IRR) for each project.
d. Draw the net present value profiles for both projects on the same set of axes, and
discuss any conflict in ranking that may exist between NPV and IRR.
e. Summarize the preferences dictated by each measure, and indicate which project
you would recommend. Explain why.

Answer 1

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Part a
Project A		$60,000/$20,000	3.00	Years
Project B		$100,000/$31,500	3.17	Years
Project C		$110,000/$32,500	3.38	Years
Part b
		Amount			PV
Period	PVF	A	B	C	A	B	C
Year 0	1.0000	$                      (60,000)	$   (100,000)	$   (110,000)	$     (60,000)	$   (100,000)	$   (110,000)
Year 1-5	3.51723	$                         20,000	$       31,500	$       32,500	$       70,345	$     110,793	$     114,310
NPV					$       10,345	$       10,793	$          4,310
Part c
Year		A	B	C
Year 0		$                      (60,000)	$   (100,000)	$   (110,000)
Year 1		$                         20,000	$       31,500	$       32,500
Year 2		$                         20,000	$       31,500	$       32,500
Year 3		$                         20,000	$       31,500	$       32,500
Year 4		$                         20,000	$       31,500	$       32,500
Year 5		$                         20,000	$       31,500	$       32,500
IRR	IRR(sum of all cash flow)	19.86%	17.34%	14.59%
Part d	Chart below at the end of answer
Part e	Project B as it has highest NPV

Comparative Net Present Value Profiles 70000 60000 50000 NPV - A NPV - B 40000 NPV C 30000 20000 10000 0 0 10 15 20 25 5 Discount Rate (% Net Present Value ($) LC