Question

The table below gives the initial investment and expected cash flows over the next five years for two different projects. Assume that the industry you are in expects a return of 10%, which you use as the discount rate in net present value (NPV) calculations and as the required rate of return for purposes of deciding on projects. Also, assume that management only wants to invest in projects that pay off within four years.

For each project, compute the payback period, NPV, and internal rate of return (IRR). Then explain whether each project should be accepted based on these three criteria.

Project A. Project B

Initial

Investment. $40,000. $28,000

Year. Cash Flows

1. $10,000. $10,000

2. $10,000. $13,000

3. $10,000. $5,000

4. $10,000. $5,000

5. $10,000. $6,000

Answer 1

DECISION

We must accept project B.

Since project B has Positive NPV, which means that project B has higher return then project A.

Project B has lower payback period which means Project B initial Investment can be recovered Earlier then project A.

Project B has higher IRR which represent that Project B has better return.

Since all the 3 Condition are favourable to Project B hence Project B should be Accepted.