Question

Britney Javelin Company is considering two investments, both of which cost $22,000. The cash flows are as follows: Use Appendix B and Appendix D.

Year	Project M			Project N
1		$8,000			$7,000
2		12,000			11,500
3		8,000			13,000

a. Calculate the payback period for project M and project N. (Round the final answers to 2 decimal places.)

  

	Payback period
Project M	years
Project N	years

b-1. Calculate the NPV for project M and project N. Assume a cost of capital of 9 percent. (Round "PV Factor" to 3 decimal places. Round the intermediate and final answers to the nearest whole dollar.)

	Net present value
Project M	$
Project N	$

b-2. Which of the two projects should be chosen based on the NPV method?

• Project M

• Project N

• Both

c.  Should a firm normally have more confidence in answer derived based on NPV method or Payback method?

• NPV method

• Pay back method

Answer 1

a.Project M

Cash flow in year 1 = $8,000

Cumulative cash flow in year 2 = $20,000

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

= 2 years + ($22,000 - $20,000) / $8,000

= 2 years + $2,000 / $8,000

= 2 years + 0.25

= 2.25 years.

Project N

Cash flow in year 1 = $7,000

Cumulative cash flow in year 2 = $18,500

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

= 2 years + ($22,000 - $18,500) / $13,000

= 2 years + $3,500 / $13,000

= 2 years + 0.27

= 2.27 years.

b-1.Project M

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

• Press the CF button.
• CF0= -$22,000. 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 cost of capital of 9%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 9% cost of capital is $1,617.08.

Project N

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

• Press the CF button.
• CF0= -$22,000. 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 cost of capital of 9%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 9% cost of capital is $4,139.72.

b-2.Project N should be chosen based on NPV method since it generates the largest net present value.

c.The firm should have more confidence in answer derived based on NPV method since it shows the value added if the project is accepted. Also, it considers it considers the cash flows during the life of project unlike the payback method which does not consider cash flows beyond the payback period.

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