Question

Use the cash flows from the following two projects to answer the questions below. The firms required rate of return is 11%. Make sure to show all your computations.

Year	Project A	Project B
0	-$200,000	-$200,000
1	$80,000	$100,000
2	$80,000	$100,000
3	$80,000	$100,000
4	$80,000

Assuming the firm’s required rate of return increases to 16% and that your firm only has $200,000 available to invest, which project of the two above would you chose if you used:

a.) The Profitability Index (as percentage of invested funds) as your capital rationing criterion?

b.) The Internal Rate of Return as your capital rationing criterion?

c.) The replacement chain method to evaluate mutually exclusive projects of equal size but different lifespans?

d.) Equivalent Annual Annuities to evaluate mutually exclusive projects of equal size but with different lifespans?

Answer 1

Satetement shwoing Present value of cash inflow for project A and B

Year	Project A	PVIF @ 11%	PV	Project B	PVIF @ 11%	PV
1	80000	0.9009	72072.07207	100000	0.90090	90090.09
2	80000	0.8116	64929.79466	100000	0.81162	81162.24
3	80000	0.7312	58495.3105	100000	0.73119	73119.14
4	80000	0.6587	52698.47793
			248196			244371.5

A)PI = Cash inflow/Cash outflow

Particulars	Project A	Project B
PV of cash inflow	248196	244371.4715
PV of cash outflow	200000	200000
PI	1.240978	1.221857358

B)

IRR is rate at which NPV is 0,

For project A

At 21.86% NPV comes to 0, hence IRR = 21.86%

Year	Project A	PVIF @ 21.86%	PV
1	80000	0.8206	65647.92
2	80000	0.6734	53870.62
3	80000	0.5526	44206.18
4	80000	0.4534	36275.54
			200000
Less: PV of cash out flow			200000
NPV			0

For project B

IRR = 23.375%

Year	Project B	PVIF @ 23.375%	PV
1	100000	0.81054	81053.63
2	100000	0.65697	65696.91
3	100000	0.53250	53249.73
4
			200000
Less: PV of cash out flow			200000
NPV			0

C) Statement showing NPV

Year	Project A	PVIF @ 11%	PV	Project B	PVIF @ 11%	PV
1	80000	0.9009	72072.07207	100000	0.90090	90090.09
2	80000	0.8116	64929.79466	100000	0.81162	81162.243
3	80000	0.7312	58495.3105	100000	0.73119	73119.138
4	80000	0.6587	52698.47793
			248196			244371.47
Less: PV of cash out flow			200000			200000
NPV			48196			44371

Thus project A should be choosen

D) Statement showing Equal annual revenue

Year	Project A	PVIF @ 11%	PV	Project B	PVIF @ 11%	PV
1	80000	0.9009	72072.07207	100000	0.90090	90090.09
2	80000	0.8116	64929.79466	100000	0.81162	81162.243
3	80000	0.7312	58495.3105	100000	0.73119	73119.138
4	80000	0.6587	52698.47793
			248196			244371.47
Less: PV of cash out flow			200000			200000
NPV			48196			44371
PVIFA			3.1024			2.44371
Equal Annual revenue			15535			18157

Thus project B should be choosen