Question

Consider the following two mutually exclusive projects:

Year	Cash Flow (A)	Cash Flow (B)
0	–$350,000	–$35,000
1	25,000	19,000
2	70,000	11,000
3	70,000	19,000
4	410,000	11,000

The required return on these investments is 12 percent.

Required:
(a)	What is the payback period for each project? (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)

	Payback period
Project A	years
Project B	years

(b)	What is the NPV for each project? (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g.,32.16).)

	Net present value
Project A	$
Project B	$

(c)	What is the IRR for each project? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

	Internal rate of return
Project A	%
Project B	%

(d)	What is the profitability index for each project? (Do not round intermediate calculations. Round your answers to 3 decimal places (e.g., 32.161).)

	Profitability index
Project A
Project B

(e)	Based only on the projects' NPV and IRR, which project should you finally choose?

Answer 1

Answer a.

Project A:

Company will recover $165,000 in first 3 years and remaining $185,000 in year 4.

Payback Period = 3 + $185,000/$410,000
Payback Period = 3.45 years

Project B:

Company will recover $30,000 in 2 years and remaining $5,000 in year 3

Payback Period = 2 + $5,000/$19,000
Payback Period = 2.26 years

Answer b.

Project A:

Present Value of Cash Inflows = $25,000/1.12 + $70,000/1.12^2 + $70,000/1.12^3 + $410,000/1.12^4
Present Value of Cash Inflows = $388,512.03

NPV = Present Value of Cash Inflows - Initial Investment
NPV = $388,512.03 - $350,000
NPV = $38,512.03

Project B:

Present Value of Cash Inflows = $19,000/1.12 + $11,000/1.12^2 + $19,000/1.12^3 + $11,000/1.12^4
Present Value of Cash Inflows = $46,247.94

NPV = Present Value of Cash Inflows - Initial Investment
NPV = $46,247.94 - $35,000
NPV = $11,247.94

Answer c.

Project A:

Let IRR be i%

NPV = -$350,000 + $25,000/(1+i) + $70,000/(1+i)^2 + $70,000/(1+i)^3 + $410,000/(1+i)^4
0 = -$350,000 + $25,000/(1+i) + $70,000/(1+i)^2 + $70,000/(1+i)^3 + $410,000/(1+i)^4

Using financial calculator, i = 15.49%

IRR of Project A = 15.49%

Project B:

Let IRR be i%

NPV = -$35,000 + $19,000/(1+i) + $11,000/(1+i)^2 + $19,000/(1+i)^3 + $11,000/(1+i)^4
0 = -$35,000 + $19,000/(1+i) + $11,000/(1+i)^2 + $19,000/(1+i)^3 + $11,000/(1+i)^4

Using financial calculator, i = 27.50%

IRR of Project A = 27.50%

Answer d.

Project A:

Profitability Index = Present Value of Cash Inflows / Initial Investment
Profitability Index = $338,512.03 / $350,000
Profitability Index = 0.97

Project B:

Profitability Index = Present Value of Cash Inflows / Initial Investment
Profitability Index = $46,247.94 / $35,000
Profitability Index = 1.32

Answer e.

Based on NPV, project A should be accepted. Based on IRR, project B should be selected. So, Project A should be selected.