Question

Project C0 C1 C2 C3 C4 C5

A -2000 +2000 0 0 0 0

B -3000 +2000 +1000 +2000 +1000 0

C -4000 +0 +2000 +1000 +1000 +3000

1. If the opportunity cost of capital is 12%, which projects have positive NPVs? Which

projects would a firm accept using the NPV rule?

2. Calculate the payback period of each project. Which project(s) would a firm using the

payback rule accept if the cutoff period were three years?

Answer 1

1. Project's A NPV is computed as follows:

= - 2,000 + 2,000 / 1.12

= - 214.29 Approximately

Project's B NPV is computed as follows:

= - 3,000 + 2,000 / 1.12 + 1,000 / 1.12² +  2,000 / 1.12³ + 1,000 / 1.12⁴

= 1,641.99 Approximately

Project's C NPV is computed as follows:

= - 4,000 +  2,000 / 1.12² +  1,000 / 1.12³ + 1,000 / 1.12⁴ + 3,000 / 1.12⁵

= 643.97 Approximately

The Project B and Project C has positive NPV's and these will be accepted.

2. The payback period is computed as shown below:

Payback period of project A is computed as follows:

= 2,000 / 2,000

= 1 year

Payback period of project B is computed as follows:

3,000 will be recovered in 2 years, hence the payback period is 2 years

Payback period of project C is computed as follows:

4,000 will be recovered in 4 years, hence the payback period is 4 years.

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