Question

JB Hi-Fi management is considering the two following options of buying a new equipment for a new investment project with the same initial cost. Year:- 0 , 1, 2, 3, 4 Project A :-, -$78500, $43000, $29000, $23000, $21000, Project B:-, -$78500, $21000, $28000 , $34000, $41000 A) which project the company should choose based on NPV Criterion if the required rate of return is 11%. B) Which project the company should choose based on P1 criterion if the required rate of return is 11%. C) Which project the company should choose if the payback criterion of minimum 3 years applies. D) After selecting the optimum project the company is thinking of financing the project which costs totally 1 million dollars by a capital structure of 40% of debt and 60% of equity . The dividend paid out to shareholders at the end of financial year is $1800000. Define the net profit of the company in the current year by applying the residual theory. E) compute the dividend payout ratio.

Answer 1

NPV Criteria:
Project-A:						Project-B:
Year	Cashflows($)	DF @ 11%	P.V.($)			Year	Cashflows ($)	DF @ 11%	P.V. ($)
0	-78500	1	-78500			0	-78500	1	-78500
1	43000	0.900901	38738.74			1	21000	0.900901	18918.92
2	29000	0.811622	23537.05			2	28000	0.811622	22725.43
3	23000	0.731191	16817.4			3	34000	0.731191	24860.51
4	21000	0.658731	13833.35			4	41000	0.658731	27007.97
		NPV	14426.54					NPV	15012.82
On the basis of NPV criteria company should select Project:B

PI Criteria:
Project -A:
Profitability Index =		(NPV+Initial Investment)/Initial Investment
	=	(14426.54+78500)/78500
		1.18
Project-B:
Profitability Index =		(NPV+Initial Investment)/Initial Investment
	=	(15012.82+78500)/78500
		1.19
On the basis of PI criteria company should select Project:B

Payback Criteria:
Project-A:						Project-B:
Year	Cashflows($)	DF @ 11%	P.V.($)	Cumulative		Year	Cashflows ($)	DF @ 11%	P.V. ($)
0	-78500	1	-78500	-78500		0	-78500	1	-78500	-78500
1	43000	0.900901	38738.74	-39761.2613		1	21000	0.900901	18918.92	-59581.1
2	29000	0.811622	23537.05	-16224.2107		2	28000	0.811622	22725.43	-36855.7
3	23000	0.731191	16817.4	593.191073	Recovered in 3 years	3	34000	0.731191	24860.51	-11995.1	$11995.10 yet to be recovered after 3 years

On the basis of payback Criteria , company should select Project-A

Define the net profit of the company in the current year by applying the residual theory
Investment Required			78500
Financed by Equity			47100
Financed by Debt			31400
Net profit of the company in the current year by applying the residual theory
=	Dividend Distributed to Shareholders + Amount to be invested in the project
=	47100+1800000
	1847100
Compute the dividend payout ratio.
=	1800000/1847100
	0.974500568
	97%