Question

Mohsin Group of Companies is planning to invest $ 150,000 on a project. The finance manager of Mohsin Group of Companies has estimated the annual cash inflows of two different projects i.e. project A and Project B as below:

Particulars	Project A	Project B
Initial Investment	150,000	150,000
Annual Cash inflows
Year
1	25,000	40,000
2	30,000	45,000
3	35,000	45,000
4	40,000	45,000
5	25,000	40,000

As Finance Executive of Mohsin Group of Companies, you are required to evaluate the above two projecting using

(a) Payback Period

(b) Net Present Value at 10% cost of capital

(c) Recommend which project is to be chosen by the company based on both the methods.                                                                                                                                             

Answer 1

Answer:
a) Calculation of payback period
Formula
Payback period = Year before full recovery of cost + Balance cost to be recovered/cash inflow during the year
Project A				`
Calculation of cummulative cash inflow		Calculation of cummulative cash inflow
Year	Cash inflows	Cummulative inflows		Year	Cash inflows	Cummulative inflows
1	25,000.00	25,000.00		1	40,000.00	40,000.00
2	30,000.00	55,000.00		2	45,000.00	85,000.00
3	35,000.00	90,000.00		3	45,000.00	130,000.00
4	40,000.00	130,000.00		4	45,000.00	175,000.00
5	25,000.00	155,000.00		5	40,000.00	215,000.00
Initial cost =	$150,000			Initial cost =	$150,000
Payback period = 4 years + ($150000 - $130000)/25000	Payback period = 4 years + ($150000 - $130000)/45000
	= 4 years + 20000/25000			= 4 years + 20000/45000
	= 4 years + .80 year			= 4 years + .44 year
	= 4.80 years				= 4.44 years

b)
Calculation of NPV
Formula will will use here
NPV =	Present value of Cash inflows - Initial cost
Project A					NPV of Project B
Initial cost =	150000.00				Initial cost =	150000.00
Year	Cash Inflows	Present value factor @ 10%	Present value of cash inflows		Year	Cash Inflows	Present value factor @ 10%	Present value of cash inflows
1	25000.00	0.90909	22727.27		1	40000.00	0.90909	36363.64
2	30000.00	0.82645	24793.39		2	45000.00	0.82645	37190.08
3	35000.00	0.75131	26296.02			45000.00	0.75131	33809.17
4	40000.00	0.68301	27320.54			45000.00	0.68301	30735.61
5	25000.00	0.62092	15523.03		3	40000.00	0.62092	24836.85
Total	116660.25		Total	162935.34
NPV of Project A					NPV of Project B
Present vallue of cash inflows	116660.25			Present vallue of cash inflows	162935.34
Less: Initial cost		150000.00			Less: Initial cost		150000.00
NPV of Project A		-33339.75			NPV of Project B		12935.34

c) As per payback period method and NPV method project B should be chosen.