Question

1. Zenith Corporation is deciding between the introduction of two new automobiles: a traditional gasoline-powered model, or a hydrogen fuel-cell model. Incremental cash flows in millions are estimated to be:

Year	0	1	2	3	4
Gas-Powered	-100	50	50	40	30
Fuel Cell	-500	100	200	200	300

Assume end-of-year cash flows, and that the appropriate discount rate for NPV analysis is 12%.

(a) Compute each project’s payback period.

(b) What is each project’s internal rate of return?

(c) Compute each project’s net present value.

(d) Assuming Zenith's goal is to maximize firm value, which project should be taken? Support your answer, including a short statement of which evaluation criterion was most relevant, which were less relevant, and why.   

Answer 1

	Gas -powered				Fuel cell
1-	Year	cash flow	cumulative cash flow		Year	cash flow	cumulative cash flow
	0	-100			0	-500
	1	50	50		1	100	100
	2	50	100		2	200	300
	3	40			3	200	500
	4	30			4	300
	Payback period	2 Years	as entire amount of initial investment is recoverable in year 2 so payback period is 2 Years		Payback period	3 Years	as entire amount of initial investment is recoverable in year 3 so payback period is 2 Years
	Year	cash flow	present value of cash flow = cash flow/(1+r)^n r= 12%		Year	cash flow	present value of cash flow = cash flow/(1+r)^n r= 12%
	0	-100	-100		0	-500	-500
	1	50	44.642857		1	100	89.28571
	2	50	39.859694		2	200	159.4388
	3	40	28.47121		3	200	142.356
	4	30	19.065542		4	300	190.6554
	NPV	sum of present value of cash flow	32.039303		NPV	sum of present value of cash flow	81.73596
	IRR - using irr function in M S excel =irr(-100,50,50,40,30)		27.89%		IRR - using irr function in M S excel =irr(-500,100,100,200,300)		18.42%
		Gas -powered	Fuel cell
	Pay back period	2	3	on the basis of pay back period Gas powered should be selected as its payback period is less than fuel cell
	IRR	27.89%	18.42%	on the basis of IRR Gas powered should be selected as its IRR is greater than fuel cell
	NPV	32.0393	81.735963	on the basis of NPV Fuel cell should be selected as its NPV is more than Gas powered
	to conclude we can say that Fuel cell should be selected as its NPV is higher than gas power and NPV is the best technique of capital budgeting decision