Question

Problem 5-19 Comparing Investment Criteria

Consider two mutually exclusive new product launch projects that Nagano Golf is considering. Assume the discount rate for both products is 13 percent.

  

Project A:	Nagano NP-30.
	Professional clubs that will take an initial investment of $570,000 at Time 0.
	Next five years (Years 1–5) of sales will generate a consistent cash flow of $205,000 per year.
	Introduction of new product at Year 6 will terminate further cash flows from this project.

Project B:	Nagano NX-20.
	High-end amateur clubs that will take an initial investment of $400,000 at Time 0.
	Cash flow at Year 1 is $120,000. In each subsequent year cash flow will grow at 10 percent per year.
	Introduction of new product at Year 6 will terminate further cash flows from this project.

  

Year	NP-30			NX-20
0	–$	570,000		–$	400,000
1		205,000			120,000
2		205,000			132,000
3		205,000			145,200
4		205,000			159,720
5		205,000			175,692

Complete the following table: (Do not round intermediate calculations. Round your "PI" answers to 3 decimal places, e.g., 32.161, and other answers to 2 decimal places, e.g., 32.16. Enter your IRR answers as a percent.)

  

	NP-30			NX-20
Payback		years			years
IRR		%			%
PI
NPV	$			$

Answer 1

NP-30
Year	Cash flow stream	Cumulative cash flow
0	-570000	-570000
1	205000	-365000
2	205000	-160000
3	205000	45000
4	205000	250000
5	205000	455000
Payback period is the time by which undiscounted cashflow cover the intial investment outlay
this is happening between year 2 and 3
therefore by interpolation payback period = 2 + (0-(-160000))/(45000-(-160000))
2.78 Years
NX-20
Year	Cash flow stream	Cumulative cash flow
0	-400000	-400000
1	120000	-280000
2	132000	-148000
3	145200	-2800
4	159720	156920
5	175692	332612
Payback period is the time by which undiscounted cashflow cover the intial investment outlay
this is happening between year 3 and 4
therefore by interpolation payback period = 3 + (0-(-2800))/(156920-(-2800))
3.02 Years
NP-30
IRR is the rate at which NPV =0
IRR	0.233915218
Year	0	1	2	3	4	5
Cash flow stream	-570000	205000	205000	205000	205000	205000
Discounting factor	1	1.233915	1.522547	1.878694	2.3181487	2.860399
Discounted cash flows project	-570000	166137.8	134642.8	109118.4	88432.638	71668.33
NPV = Sum of discounted cash flows
NPV NP-30 =	3.75294E-07
Where
Discounting factor =	(1 + IRR)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	23.39%
NX-20
IRR is the rate at which NPV =0
IRR	0.224480584
Year	0	1	2	3	4	5
Cash flow stream	-400000	120000	132000	145200	159720	175692
Discounting factor	1	1.224481	1.499353	1.835928	2.2480585	2.752704
Discounted cash flows project	-400000	98000.74	88037.99	79088.06	71047.972	63825.24
NPV = Sum of discounted cash flows
NPV NX-20 =	1.74732E-07
Where
Discounting factor =	(1 + IRR)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	22.45%
NP-30
PI= (NPV+initial inv.)/initial inv.
=(151032.41+570000)/570000
1.26
NX-20
PI= (NPV+initial inv.)/initial inv.
=(103518.78+400000)/400000
1.26
NP-30
Discount rate	0.13
Year	0	1	2	3	4	5
Cash flow stream	-570000	205000	205000	205000	205000	205000
Discounting factor	1	1.13	1.2769	1.442897	1.6304736	1.842435
Discounted cash flows project	-570000	181415.9	160545.1	142075.3	125730.34	111265.8
NPV = Sum of discounted cash flows
NPV NP-30 =	151032.41
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
NX-20
Discount rate	0.13
Year	0	1	2	3	4	5
Cash flow stream	-400000	120000	132000	145200	159720	175692
Discounting factor	1	1.13	1.2769	1.442897	1.6304736	1.842435
Discounted cash flows project	-400000	106194.7	103375.4	100630.9	97959.267	95358.58
NPV = Sum of discounted cash flows
NPV NX-20 =	103518.78
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor