Question

Your division is considering two projects. Your division’s WACC is 10%, and the projects’ after-tax cash flows (in millions of dollars) would be as follows: (Time Period is in terms of years.) Please keep two decimals for your results, i.e., 4.55 years, 3.09%, $98.98, etc.

Time 0. 1.    2. 3. 4

Project A. -1,000. 100. 300. 500. 600

Project B. -1,000. 600. 600. 200. 100

Calculate the Discounted Payback Period of Project A: (14’)

Project A
Time Period:	0	1	2	3	4
Cash Flow:	(1,000) or -1,000	100	300	500	600
Discounted Cash Flow:
Cumulative Discounted Cash Flow:

NPV: (8’)

Using your financial calculator, calculate the NPV of each project:

NPV_A =

NPV_B =

According to NPV, if they are independent projects, which project (or projects) should your division accept? If they are mutually exclusive projects, which project (or projects) should your division accept?

If they are independent projects:

If they are mutually exclusive projects:

IRR (8’):

Using your financial calculator, calculate the IRR of each project:

IRR_A =

IRR_B =

According to IRR, if they are independent projects, which project (or projects) should your division accept? If they are mutually exclusive projects, which project (or projects) should your division accept?

If they are independent projects:

If they are mutually exclusive projects:

Answer 1

Year (1)	Discount factor 10% (2)	Project A (3)	PV of A/Discounted cash flow (4) = (2) * (3)	Cumulative discounted cash inflow of A (5)	Project B (6)	PV of B/Discounted cash flow (7) = (2) * (6)	Cumulative discounted cash inflow of B (8)
0	1	1000 (outflow)	1000	-	1000 (outflow)	1000	-
1	0.909	100	90.9	90.9	600	545.4	545.4
2	0.826	300	247.8	90.9+247.8 =338.7	600	495.6	545.4+495.6 =1041
3	0.751	500	375.5	338.7+375.5= 714.2	200	150.2	1041+150.2=1191.2
4	0.683	600	409.8	714.2+409.8 = 1124	100	68.3	1191.2+68.3=1259.5

Discounted Payback Period of Project A = completed years + remaining amount / available amount

Discounted payback period is calculated in the same way as the payback period except that the future cash inflows are first discounted and then the payback is calculated. It is better than payback period since time value of money is also considered.

(Discounted cash flows are used to calculate discounted pay back period)

Sum of Present values of cash inflows of A = 90.9 + 247.8 + 375.5 + 409.8 = 1124

So 1124 amount is obtained in 4 years , so 1000 = 4/1124 * 1000 = 3.5587 = 3.56 years

Net present value = present value of cash inflow - present value of cash outflow

A = 90.9 + 247.8 + 375.5 + 409.8 - 1000 = 124

B = 545.4 + 495.6 +150.2 + 68.3 -1000 = 259.5

Independent projects are those projects where in occurence of one does not affect the occurence of the other

Mutually exclusive projects are those projects wherein two project cannot happen simultaneously

According to NPV, if they are independent projects, which project (or projects) should your division accept? If they are mutually exclusive projects, which project (or projects) should your division accept?

If they are independent projects: Both can be accepted since NPV is positive

If they are mutually exclusive projects: Project B should be selected

IRR is the rate at which NPV is zero, i.e. Present value of cash inflow = Present value of cash outflows

IRR can be calculated by hit and trial method at different discount rates and thereby determining the NPV at those discount rates.

Project A = 14.44%

Project B = 25.54%

In both cases, IRR > WACC So both are desirable projects i.e. can be accepted.

According to IRR, if they are independent projects, which project (or projects) should your division accept? If they are mutually exclusive projects, which project (or projects) should your division accept?

If they are independent projects: Both

If they are mutually exclusive projects: Project B because higher NPV

( if any query please comment. I will reply in the comments)