Question

Please calculate the payback period, IRR, MIRR, NPV, and PI for the following two mutually exclusive projects. The required rate of return is 15% and the target payback is 4 years. Explain which project is preferable under each of the four capital budgeting methods mentioned above:

Table 1

Cash flows for two mutually exclusive projects

Year	Investment A	Investment B
0	-$5,000,000	-5,000,000
1	$1,500,000	$1,250,000
2	$1,500,000	$1,250,000
3	$1,500,000	$1,250,000
4	$1,500,000	$1,250,000
5	$1,500,000	$1,250,000
6	$1,500,000	$1,250,000
7	$2,000,000	$1,250,000
8	0	$1,600,000

Answer 1

Answer :

Calculation of Payback Period :

Payback Period of Investment A = Initial Investment / Annual Cash Flows

= 5,000,000 / 1,500,000

= 3.33 years.

Payback Period of Investment A = Initial Investment / Annual Cash Flows

= 5,000,000 / 1,250,000

= 4 years

When using payback period method as a criteria we will chhose Investment A because it has lower Payback Period.

Calculation of Net Present value of Investment A :

Net Present Value = Present value of cash Inflow - Present value of Cash Outflow

Year	Cash Inflow	Present Value Factor @ 15%	Present value of cash inflow
1	1500000	0.869565217	1304347.826
2	1500000	0.756143667	1134215.501
3	1500000	0.657516232	986274.3486
4	1500000	0.571753246	857629.8684
5	1500000	0.497176735	745765.1029
6	1500000	0.432327596	648491.3939
7	2000000	0.37593704	751874.0798
8	0	0.326901774	0
		Total Present value of cash inflow	6428598.121
		Less : Cash outflow	5000000
		Net Present Value	1,428,598.1207

Calculation of Net Present value of Investment B :

Net Present Value = Present value of cash Inflow - Present value of Cash Outflow

Year	Cash Inflow	Present Value Factor @ 15%	Present value of cash inflow
1	1250000	0.869565217	1086956.522
2	1250000	0.756143667	945179.5841
3	1250000	0.657516232	821895.2905
4	1250000	0.571753246	714691.557
5	1250000	0.497176735	621470.9191
6	1250000	0.432327596	540409.4949
7	1250000	0.37593704	469921.2999
8	1600000	0.326901774	523042.8382
		Total Present value of cash inflow	5723567.505
		Less : Cash outflow	5000000
		Net Present Value	723,567.5055

Since NPV of Investment A is more than NPV of Investment B therefore Investment A should be selected .

Calculation of IRR and MIRR

IRR of Investment A : 23.80%

IRR of Investment B : 19.19%

MIRR of Investment A : 18.67%

MIRR of Investment B : 16.96%

Below is the image showing calulation of IRR and MIRR of Both investment

Using IRR as a criteria Investment A will be preferred as it has higher IRR.Though both investment IRR is more than required return but the one with highest IRR is preferrrable in case of mutually exclusive projects.

Using MIRR as a criteria Investment A will be preferred as it has higher MIRR.