Question

Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown below. The required rate of return on projects of both of their risk class is 8 percent, and that the maximum allowable payback and discounted payback statistic for the projects are 2 and 3 years, respectively. Time: 0 1 2 3 Project A Cash Flow -20,000 10,000 30,000 1,000 Project B Cash Flow -30,000 10,000 20,000 50,000

Use the NPV decision rule to evaluate these projects; which one(s) should be accepted or rejected?

Answer 1

Time	Project A	PV F at 8%	PV at 8%	Project B	PV at 8%
0	-20000	1	-20000	-30000	-30000
1	10000	0.92593	9259.26	10000	9259.259
2	30000	0.85734	25720.16	20000	17146.78
3	1000	0.79383	793.83	50000	39691.61
	NPV		15773.26		36097.65

Ordinary Payback
Time	Project A	Cum.		Time	Project B	Cum.
0	-20000	-20000		0	-30000	-30000
1	10000	-10000		1	10000	-20000
2	30000	20000		2	20000	0
3	1000	21000		3	50000	50000
	21000				50000
Payback period=1+(10000/30000)=				Payback period=1+(20000/20000)=
	1.33	Years			2	Years

Discounted payback period:
Time	Project A	PV F at 8%	PV at 8%	Cum.
0	-20000	1	-20000	-20000
1	10000	0.92593	9259.26	-10740.74
2	30000	0.85734	25720.16	14979.42
3	1000	0.79383	793.83	15773.26
			15773.26
Disc.Payback period=1+(10740.74/25720.16)=
	1.42	Years
Time	Project B	PV F at 8%	PV at 8%	Cum.
0	-30000	1	-30000	-30000
1	10000	0.92593	9259.26	-20740.74
2	20000	0.85734	17146.78	-3593.96
3	50000	0.79383	39691.61	36097.65
			36097.65
Disc.Payback period=2+(3593.96/39691.61)=
	2.09	Years
Summary
	Payback (in Yrs.)	Disc.P/B(in Yrs.)	NPV
Project A	1.33	1.42	15773.26
Project B	2	2.09	36097.65
Select	A	A	B
Final decision
Project B
For its greater NPV