Question

Calculate the Net Present Value given two proposed projects of AIM Manufacturing Corp.

Project # 1:

Initial Investment: $100,000

Cash Inflows:

Year 1: $45,000

Year 2: $48,000

Year 3: $55,000

Year 4: $75,000

Year 5: $150,000

Project # 2:

Initial Investment: $100,000

Cash Inflows:

Year 1: $65,000

Year 2: $45,000

Year 3: $25,000

Year 4: $10,000

Year 5: $1,000

What are the Payback Period for each project using the NPV Method? Which project would you select in you were looking for higher cash inflows in your capital budget? Why....

Answer 1

NPV is calculated below-

Project 1
Year	Cash flow	8% Discounted factor	Discounted cash flows
1	45000	0.926	41666.67
2	48000	0.857	41152.26
3	55000	0.794	43660.77
4	75000	0.735	55127.24
5	150000	0.681	102087.48
			181606.94
		Initial Investment	100000
		NPV	81606.94

Project 2
Year	Cash flow	8% Discounted factor	Discounted cash flows
1	65000	0.926	60185.19
2	45000	0.857	38580.25
3	25000	0.794	19845.81
4	10000	0.735	7350.30
5	1000	0.681	680.58
			125961.54
		Initial Investment	100000
		NPV	25961.54

Thus, NPV of Project 1 is higher which should be selected.

Payback Period

A + B/C

Formula- Period with negative cumulative cash flow+ Absolute value of cash flow at end of period A/ Total cash inflow during A

Project 1
Year	Cash flow	Cumulative
0	-100000	-100000
1	45000	-55000
2	48000	-7000
3	55000	48000
4	75000	123000
5	150000	273000
	Payback Period	2.13

Project 2
Year	Cash flow	Cumulative
0	-100000	-100000
1	65000	-35000
2	45000	10000
3	25000	35000
4	10000	45000
5	1000	46000
	Payback Period	1.78

Thus, payback period of project 2 is accepted. However, by looking at NPV, it can be said that Project 1 should be selected because over the time, investment made will yield higher returns than Project 2.