Question

Strand Plc has the following two mutually exclusive projects available to invest in. the discount rate is 10%. Each project can be undertaken only once.

Cash flows

Project Initial cost Year 1    Year 2 Year 3

1 (500) 400    200    100

2 (1000) 500    400 500

Required:

(a) Calculate the payback period for each of the projects. Based upon the payback criterion which project should be chosen?

(b) Calculate the net present value (NPV) of each project. Based upon the NPV criterion which project should be chosen?

(c) Based on your calculations in (a) and (b) above, what is the final decision concerning which project should be chosen?

Answer 1

Ans:

Cash Flow Table:

Project 1:

Year	(Outflow)/ Inflow Project 1	PV Factor @10%	Net present value of inflow /(Outflow)
0	(500)	1.00	(500)
1	400	0.90909	364
2	200	0.82645	165
3	100	0.75131	75
		NPV of Project	$104

Payback period :

Total to be recoevred : $500

Year 1 : $400

Year 2: $200

Pyaback period : 1 + $100/$200 = 1.5 Years

Project 2:

Year	(Outflow)/ Inflow Project 2	PV Factor @10%	Net present value of inflow /(Outflow)
0	(1,000)	1.00	(1,000)
1	500	0.90909	454
2	400	0.82645	331
3	500	0.75131	376
		NPV of Project	$161

Payback period :

Total to be recoevred : $500

Year 1 : $500

Year 2: $400

Year 3 : $500

Pyaback period : 2 + $100/$500 = 2.2 Years

3.

Based on above project 1 is to be chosen, because it has low payback period and High return on investment done.

Note: If solely on the basis of NPV, Project 2 should be selected.

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