Question

Consider the following two mutually exclusive projects:

Year	Cash Flow (Project I)	Cash Flow (Project II)
0	-$12,300	-$44,000
1	$1,800	$14,000
2	$6,000	$30,000
3	$2,000	$5,000
4	$5,000	$10,000
5	$7,000	$5,000

The required return is 10% for both projects. Assume that the internal rate of return (IRR) of Project I and Project II is 18% and 15%, respectively.

1. a) Which project will you choose if you apply the NPV criterion? Why?

2. b) Which project will you choose if you apply the payback criterion? Why?
   

3. c) Which project will you choose if you apply the IRR criterion? Why?

4. d) Based on the above answers, which project will you finally choose? Why?
   

Answer 1

1) Project II will be selected since, NPV of project II is higher than the NPV of project I

Project I
Year	Cashflow	PVF @10%	Cashflow * PVF
0	$       -12,300	1.0000	$       -12,300.00
1	$           1,800	0.9091	$           1,636.36
2	$           6,000	0.8264	$           4,958.68
3	$           2,000	0.7513	$           1,502.63
4	$           5,000	0.6830	$           3,415.07
5	$           7,000	0.6209	$           4,346.45
NPV	$           3,559.19

Project II
Year	Cashflow	PVF @10%	Cashflow * PVF
0	$       -44,000	1.0000	$       -44,000.00
1	$         14,000	0.9091	$         12,727.27
2	$         30,000	0.8264	$         24,793.39
3	$           5,000	0.7513	$           3,756.57
4	$         10,000	0.6830	$           6,830.13
5	$           5,000	0.6209	$           3,104.61
NPV	$           7,211.98

b) Project II will be selected since, payback of project II is lower than the payback of project I

Project I
Year	Cashflow	cummulative cashflow
0	$       -12,300
1	$           1,800	$                 1,800
2	$           6,000	$                 7,800
3	$           2,000	$                 9,800
4	$           5,000	$               14,800
5	$           7,000	$               21,800
Payback	3.5 years	=>3years+(12300-9800)/5000

Project II
Year	Cashflow	cummulative cashflow
0	$       -44,000
1	$         14,000	$               14,000
2	$         30,000	$               44,000
3	$           5,000	$               49,000
4	$         10,000	$               59,000
5	$           5,000	$               64,000
Payback	2years

c)  Internal rate of return (IRR) of Project I and Project II is 18% and 15%, respectively, project I will be selected based on IRR being higher IRR

d) Project II is selcted being higher NPV and lower payback period

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