Question

A firm has a WACC of 11.04% and is deciding between two mutually exclusive projects. Project A has an initial investment of $64.71.

The additional cash flows for Project A are:

Year 1 = $17.65

Year 2 = $38.98

Year 3 =$44.55.

Project B has an initial investment of $70.01. The cash flows for Project B are:

Year 1 = $54.71

Year 2 = $48.39

year 3 = $39.00.

Calculate the following:

•Payback Period for Project A:

•Payback Period for Project B:

•NPV for Project A:

•NPV for Project B:

Answer 1

Solution:
	Payback Period for Project A	2.18	Years
	Payback Period for Project B	1.32	Years
	NPV for Project A	15.34
	NPV for Project B	46.99
Notes:	Since both the projects are mutually exclusive , any of the project can be selected , so here project B seems very good position than project A , we can see it have less payback period and More NPV than project B.
Working Notes:
Notes:	The payback period shows the period at which the project repays the cash flows invested in the project.
	Determination of payback period for both projects.
	Project A		Project B
Year	Cash Flow -A	Cumulative cash In-Flow	Cash Flow- B	Cumulative cash In-Flow
0	-64.71	-64.71	-70.01	-70.01
1	17.65	-47.06	54.71	-15.30
2	38.98	-8.08	48.39	33.09
3	44.55	36.47	39	72.09
	Project A payback period is between 2nd and 3rd period as cumulative cash flow becomes positive in 3rd year
	Project A Payback period = 2 years + Remaining balance/3rd year cash inflows
		= 2 + 8.08/44.55
		= 2.181369248
		=2.18 years
	Project B payback period is between 1st and 2nd period as cumulative cash flow becomes positive in 2nd year
	Project A Payback period = 1 year + Remaining balance/2nd year cash inflows
		= 1 + 15.30/48.39
		= 1.31618
		=1.32 years
Now	NPV we calculate using as WACC as discount rate to discount cash flow of the projects as at WACC is cost of investment in project which will be suitable discount rate.
	a	b	c = a x b	d	e= d x b
Year	Project -A	PVF @ 11.04% WACC	Present value	Cash Flow- B	Present value
0	-64.71	1	-64.7100	-70.01	-70.01
1	17.65	0.900576	15.8952	54.71	49.2705
2	38.98	0.811038	31.6143	48.39	39.2461
3	44.55	0.730401	32.5394	39	28.4857
	Total	NPV Project A	15.34	NPV Project B	46.99
Notes: PVF is calculated @ r% is at WACC 11.04% = 1/(1+r%)^n = 1/(1+ 0.1104)^n    where n is the period for which PVF is calculated.
Please feel free to ask if anything about above solution in comment section of the question.