Question

1. (a) If management requires projects to have a 3-year payback, would it accept either of the following two independent projects? Explain.

  

Year 0 1 2 3 4

Cash flows (A) -$55,000 19,000 19,000 19,000 19,000

Cash flows (B) -$95,000 18,000 18,000 18,000 230,013

               

(b) What is the NPV of project B assuming the discount rate is 14%.

(c) Sketch the NPV profile for project B. Also indicate the point when the discount rate is 37.01%.

2. A company is evaluating the following two mutually exclusive projects. The company mandates a three-year project payback. The required return is 10%.

  

Year Project F

0. 0 -$150,000

1. 1 44,000

2. 2 68,000

3. 3 40,000

4. 4 60,000

5. 5 54,000

Project G -$235,000 77,000 77,000 77,000 77,000 77,000

                  

(a) Calculate the payback period for both projects.
(b) Calculate the NPV for both projects.
(c) Calculate the PI for both projects.
(d) Which project, if any, should the company accept? (e) What can we infer about the IRRs for these projects?

3. Evaluate each of the following statements to determine if they are ‘True’ or ‘False’. (a) A one-year project costing $1,000 and with an IRR of 15% should be accepted.

(b) The PV of the cash flows of an eight-year project equals $580. If the discount rate is 8%, and the project costs $500 then it should be rejected.

(c) The payback period is most appropriate for projects with a long life.

Answer 1

Ans 1 a) If the payback period is 3 years then project A can be accepted because in three years project A will payback the investment amount. Investment amount for project is $55,000 in 3 year it will pay back $57000 ($19000 * 3). Thus the project A will be selected as per the pay back period condition.

Ans 1 b) NPV of project B at 14% discount rate = Initial cash flow + 1st year cash flow/(1 + discount rate) + 2nd year cash flow/(1 + discount rate)^2 + + 3rd year cash flow/(1 + discount rate)^3 +  4th year cash flow/(1 + discount rate)^4

= -95000 + 18000/(1.14) + 18000/(1.14)^2 + 18000/(1.14)^3 + 230013/(1.14)^4

= -95000 + 15789.47 + 13850.42 + 12149.49 + 136186.2

= $72785.56

Ans 1 c)