Question

Novell, Inc., has the following mutually exclusive projects.

  

Year		Project A		Project B
0		–$27,000		–$30,000
1		15,500		16,500
2		12,000		10,500
3		3,600		12,000

a-1.	Calculate the payback period for each project. (Do not round intermediate calculations and round your answers to 3 decimal places, e.g., 32.161.)

Project A: Years

Project B: Years

a-2.	If the company's payback period is two years, which, if either, of these projects should be chosen?
	Project A Project B Both projects Neither project

b-1.	What is the NPV for each project if the appropriate discount rate is 14 percent? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Project A:

Project B:

b-2.	Which, if either, of these projects should be chosen if the appropriate discount rate is 14 percent?
	Project A Project B Both projects Neither project

      

Answer 1

a-1)

Payback period is the amount of time it takes to recover the initial investment

For Project A

amount to be paid after year 1 = 27000 - 15500 = 11500

Payback period of A = 1 + (11500/12000)

= 1.98 years

For Project B

amount to be paid after year 2 = 30000 - 16500 - 10500

= 3000

payback period of B = 2 + (3000/12000)

= 2.25 years

a-2)

Hence choose Project A, since it is the only project with payback period less than 2 years

b-1)

NPV = -initial investment + PV of future cash flows

Present value = Future value/(1+i)^n

i = interest rate per period

n= number of periods

NPV of A= -27000 + 15500/1.14 + 12000/1.14^2 + 3600/1.14^3

= -1740

NPV of B = -30000 + 16500/1.14 + 10500/1.14^2 + 12000/1.14^3

= 62.75

b-2)

Choose project B , since NPV is positive