Question

Initial Outlay               10000                          500000

Year 1                         8000                            100000

Year 2                         10000                          200000

Year 3                         5000                            300000

Year 4                         3000                            200000                                   

Year 5-10                    5000                            10000

Decide which ME project would be chosen under the following process:

1-Payback Period model

2-Discounted Payback model

3-NPV model

4-IRR model (WACC rate 5%)

5-Profitabilty Index model

Use 10 % discount rate

please show work with formulas

Answer 1

Answer:

Let us identify the two projects as ME1 and ME2.

The answer has two parts:

1. If the projects are mutually exclusive (only one project has to be chosen) the following would be choices under the 5 models:

So, if projects are mutually exclusive:

Based on payback period, discounted payback period, IRR and PI, project ME1 will be chosen since it has lower payback period, lower discounted payback period, higher IRR and higher PI.

Based on NPV, project ME2 will be chosen since it has higher NPV.

2. However, if the projects are independent:

There is no cut off given for payback period and discounted payback period.

Based on NPV, IRR and PI both projects will be chosen since both has positive NPV, IRR of both projects are greater than WACC and PI of both projects are greater than 1.

Workings:

The above excel with 'show formula' is given below: