Question

You are given the following two projects cash flows that will be used to illustrate the application of the various capital techniques in project analysis. PROJECTS / CASHFLOWS (RM) YEAR A B 0 (100,000) (120,000) 1 30,000 20,000 2 30,000 30,000 3 30,000 40,000 4 30,000 40,000 5 30,000 50,000

a. Identify the payback period for both of the project. (2mark)

b. Assume that the firm’s cost of capital is 10%, calculte the Net Present Value (NPV) for both projects. Which project will you choose if the projects are independent projects

c. Calculate the Internal Rate of Return (IRR) for both projects. (Assume the cost of capital for both projects are 10%)

d. What is the Profitability Index (PI) for both of the projects?

Answer 1

a)

The Payback period is the time in which the investors gets back the exact amount which he invested in the project.

Years	A	Cummulative Cash Flows
0	(100,000)	(100,000)
1	30,000	(70,000)
2	30,000	(40,000)
3	30,000	(10,000)
4	30,000	20,000
5	30,000	50,000

Payback period of A = 3.3 years

Years	B	Cummulative Cash Flows
0	(120,000)	(120,000)
1	20,000	(100,000)
2	30,000	(70,000)
3	40,000	(30,000)
4	40,000	10,000
5	50,000	60,000

Payback period of B = 3.75 years

b), c), d)

NPV = Initial cash outlay + PV of all the cash inflows

PV of cash flow at time n = Cash flow at time n/ ((1+r)^n)

IRR is the interest rate at which NPV = 0

0 = -CF0 + (CF1/((1+IRR)^1)) + (CF2/((1+IRR)^2)) + (CF3/((1+IRR)^3)) + (CF4/((1+IRR)^4)) + (CF5/((1+IRR)^5))

PI = 1 + (NPV/Initial Investment)

Years	A	PV
0	(100,000)	-100000
1	30,000	27273
2	30,000	24793
3	30,000	22539
4	30,000	20490
5	30,000	18628
WACC	10.00%
IRR	15.24%
NPV	13,724
PI	1.14

Years	B	PV
0	(120,000)	-120000
1	20,000	18182
2	30,000	24793
3	40,000	30053
4	40,000	27321
5	50,000	31046
WACC	10.00%
IRR	13.17%
NPV	11,394
PI	1.09

If the projects are independent projects, we can choose both the projects as both's projects NPV are positive