Question

Question 10 Unsaved Question 10 options: Cummings Products Company's cost of capital is 11.2% and the company is considering two mutually exclusive projects. In the past, it usually takes about 5 years for the company to recoup its investments from a good project. The projects' expected cash flows are as follows: Year Project A Project B 0 ($300) ($405) 1 (387) 134 2 (193) 134 3 100 234 4 600 134 5 600 134 6 650 134 7 50 0 Project A's payback period is Project B's payback period is Project A's NPV is Project B's NPV is Project A's IRR is Project B's IRR is Based on IRR, which project(s) should we choose? (Simply type A or B.) Based on payback period, which project(s) should we choose? (Simply type A or B.) Based on NPV, which project(s) should we choose? (Simply type A or B.) If you are the decision maker in this company, which project(s) would you choose? (Simply type A or B.)

Answer 1

Calculation of payback period of Project A:
Year	Cashflows	Cumulative cashflows
0	-300	-300
1	-387	-687
2	-193	-880
3	100	-780
4	600	-180
5	600	420
6	650	1070
7	50	1120
Payback period=4+180/600
Pay back period of A is 4.3 years
Calculation of payback period of Project B:
Year	Cashflows	Cumulative cashflows
0	-405	-405
1	134	-271
2	134	-137
3	234	97
4	134	231
5	134	365
6	134	499
7	0	499
Payback period=2+137/234
Pay back period of B is 2.59 years
Calculation of NPV of Project A:
Year	Cashflow(in$)(a)	[email protected]%(b)	Present value(a*b)
0	-300	1	-300.00
1	-387	0.89928	-348.02
2	-193	0.80871	-156.08
3	100	0.72725	72.73
4	600	0.65400	392.40
5	600	0.58813	352.88
6	650	0.52890	343.78
7	50	0.47563	23.78
Net Present value			381.47
Therefore net present value of project A is $381.47
Calculation of NPV of project B:
Year	Cashflow(in$)(a)	[email protected]%(b)	Present value(a*b)
0	-405	1	-405.00
1	134	0.89928	120.50
2	134	0.80871	108.37
3	234	0.72725	170.18
4	134	0.65400	87.64
5	134	0.58813	78.81
6	134	0.52890	70.87
7	0	0.47563	0.00
Net Present value			231.37
Therefore Net Present value is $231.37
Calculation of IRR:
Project A
Year	Cashflow(in$)(a)	PVF@25%(b)	Present value(a*b)
0	-300	1	-300.00
1	-387	0.80000	-309.60
2	-193	0.64000	-123.52
3	100	0.51200	51.20
4	600	0.40960	245.76
5	600	0.32768	196.61
6	650	0.26214	170.39
7	50	0.20972	10.49
Net Present value			-58.67
`
Internal rate of return=	Lower rate+	(Lower rate NPV)	*(Higher rate- lower rate)
		(lowe rate NPV- Higher rate NPV)
	11.2%+	381.47	*(25%-11.2%)
		(381.47+58.67)
	11.2%+11.96%
So IRR of project A is 23.16%
Project B
Year	Cashflow(in$)(a)	PVF@30%(b)	Present value(a*b)
0	-405	1	-405.00
1	134	0.76923	103.08
2	134	0.59172	79.29
3	234	0.45517	106.51
4	134	0.35013	46.92
5	134	0.26933	36.09
6	134	0.20718	27.76
7	0	0.15937	0.00
Net Present value			-5.36
`
Internal rate of return=	Lower rate+	(Lower rate NPV)	*(Higher rate- lower rate)
		(lowe rate NPV- Higher rate NPV)
	11.2%+	231.37	*(30%-11.2%)
		(231.37+5.36)
	11.2%+18.37%
So IRR of project B is 29.57%
B) Based on IRR project B should be chosen because its IRR is more than that of
project A.
Based on payback period Project B should be chosen because payback period of
project B is lower than Project A
Based on Net present value Project A should be chosen because NPV of
project B is lower than Project A
IF I am a decision maker then I will choose project A