Question

Garage, Inc., has identified the following two mutually exclusive projects. The required rate of return on both projects is 12%. Which project should the company choose and why?

Year	Cash Flow (A)	Cash Flow (B)
0	-$29,000	-$29,000
1	14,400	4,400
2	12,300	9,800
3	9,200	18,500
4	8,100	16,800

A: Choose A because project A has a higher IRR

B: Choose B because project B has a higher NPV

C: Choose B because project B has shorter payback period

D: Choose A because project A has higher profitability index

Answer 1

Present Value = Future value/ ((1+r)^t)
where r is the interest rate that is 12% and t is the time period in years.
Net present value (NPV) = initial investment + sum of present values of future cash flows.
Internal rate of return (IRR) is the discount rate for which the NPV is zero.
Use the financial formulas function in excel to find the IRR.
Profitability index (PI) = sum of present values of future cash flows/(initial investment)
PROJECT A
Year	0	1	2	3	4
cash flow	-29000	14400	12300	9200	8100
present value		12857.14	9805.485	6548.378	5147.696
NPV	5358.70
IRR	21.56%
Payback period	2.25 years
PI	1.185
PROJECT B
Year	0	1	2	3	4
cash flow	-29000	4400	9800	18500	16800
present value		3928.571	7812.5	13167.93	10676.7
NPV	6585.71
IRR	20.41%
Payback period	2.8 years.
PI	1.227
B: Choose B because project B has a higher NPV