Question

Solve Questions #1 (a & b) 1)

Calculating Payback Period and MPV.

Maxwell Software, Inc., has the following mutually exclusive projects

Year Project A Project B

0 $-20,000 $-24,000

1 13,200 14,100

2 8,300 9,800

3 3,200 7,600

a) Suppose the company’s payback period cutoff is two tears. Which of these two projects should be chooses?

b) Suppose the company uses the NPV rule to rank these two projects. Which project should be chosen if the appropriate discount rate is 15%?

Answer 1

a)

Project A:

Cumulative cash flow for year 0 = -20,000

Cumulative cash flow for year 1 = -20,000 + 13,200 = -6,800

Cumulative cash flow for year 2 = -6,800 + 8,300 = 1,500

6,800 / 8,300 = 0.82

Payback period of project A = 1 + 0.82 = 1.82 years

Project B:

Cumulative cash flow for year 0 = -24,000

Cumulative cash flow for year 1 = -24,000 + 14,100 = -9,900

Cumulative cash flow for year 2 = -9,900 + 9,800 = -100

Cumulative cash flow for year 3 = -100 + 7,600 = 7,500

100 / 7,600 = 0.013

Payback period of project B = 2 + 0.013 = 2.013 years

Project A should be chosen as it has a lower payback

b)

Project A:

NPV = Present value of cash inflows - present value of cash outflows

NPV = -20,000 +  13,200 / (1 + 0.15)¹ + 8,300 / (1 + 0.15)² + 3,200 / (1 + 0.15)³

NPV of project A = -141.69

Project B:

NPV = Present value of cash inflows - present value of cash outflows

NPV = -24,000 +  14,100 / (1 + 0.15)¹ + 9,800 / (1 + 0.15)² + 7,600 / (1 + 0.15)³

NPV of project A = 668.2

Project B should be chosen as it has a higher NPV