Question

Question 2 Consider the following two mutual exclusive projects Cash flow A -600,000 170,000 180,000 205,000 270,000 Cash flowB Year 600,000 220,000 390,000 220,000 350,000 4 whichever project you choose if any, would require a 6% return on your investment a) If you apply the playback criteria, which project will you choose? Why? b) If you apply the NPV payback criteria, which project will you choose? Why? c) If you apply the IRR payback criteria, which project will you choose? Why? d) If you apply the Profitability payback criteria, which project will you choose? Why Based on your answers in (a) through (d) which project will you finally choose? Why

Answer 1

Answer to Requirementa Project A Project B Cumulative Cash Cumulative Cash Cash Inflow Inflow Cash Inflow Inflow Year Year 170,000 170,000 220,000 220,000 2 180,000 350,000 2 390,000 610,000 205,000 555,000 220,000 830,000 4 270,000 825,000 4 350,000 1,180,000 Playback Period 3 years($600,000 $555,000)/ $270,000 Playback Period 1 years($600,000 $220,000)/ $390,000 Playback Period 3.17 years Playback Period 1.97 years Project B should be selected, as it has shorter Playback period

fIRR(C30:C34) Answer to Requirement b 15 16 Project A Project B PV of Cash PV of Cash Cash Flow PV Factor Flow Cash Flow PV Factor Flow Year 17 Year -600,000 1.0000 -600,000 -600,000 1.0000 -600,000 0,0000.9434 390,000 0.8900 0.9434 180,0000.8900 205,0000.8396 270,000 0.7921 170,000 160,377 207,547 19 160,199 347,099 20 172,122 220,000 0.8396 184,716 21 213,865 277,233 350,000 0.7921 Net Present Net Present Value Value 106,564 416,595 23 24 Project B should be selected, as it has higher NPV 25 26 27 Answer to Requirement c Project A Cash Flow Year 29 0 -600,000 31 170,000 180,000 32 205,000 270,000 12.93% 35

IRR(C39:C43) 36 Project B 37 Cash Flow Year 38 39 0 -600,000 220,000 41 390,000 220,000 42 43 4 350,000 32.14% 45 Project B should be selected, as it has higher IRR 47

Answer to Requirement d.

Project A:
Profitability Index = PV of Cash Inflow / Initial Investment
Profitability Index = ($160,377 + $160,199 + $172,122 + $213,865) / $600,000
Profitability Index = $706,564 / $600,000
Profitability Index = 1.18

Project B:
Profitability Index = PV of Cash Inflow / Initial Investment
Profitability Index = ($207,547 + $347,099 + $184,716 + $277,233) / $600,000
Profitability Index = $1,016,595 / $600,000
Profitability Index = 1.69

Project B should be selected, as it has higher Profitability Index.

Based on answer in (a) to (d), Project B should be selected.