Question

X-treme Vitamin Company is considering two investments, both of which cost $48,000. The cash flows are as follows:

Year	Project A			Project B
1	$	52,000		$	48,000
2		21,000			25,000
3		20,000			26,000

Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a-1. Calculate the payback period for Project A and Project B. (Round your answers to 2 decimal places.)
  

a-2. Which of the two projects should be chosen based on the payback method?
  

	Project A
	Project B

b-1. Calculate the net present value for Project A and Project B. Assume a cost of capital of 8 percent. (Do not round intermediate calculations and round your final answers to 2 decimal places.)
  

b-2. Which of the two projects should be chosen based on the net present value method?
  

	Project B
	Project A

c. Should a firm normally have more confidence in the payback method or the net present value method?
  

	Payback method
	Net present value method

Answer 1

Requirement (a)(1) - Payback period for Project A and Project B

Payback Period - Project A = 0.92 Years [$48,000 / $52,000]

Payback Period - Project B = 1.00 Year [$48,000 / $48,000]

Requirement (a)(2) - The projects to be chosen based on the payback method

“PROJECT A” should be chosen based on the payback method, since the Payback period of Project A is less than the Payback period of Project B.

Requirement (b)(1) - The Net present value for Project A and Project B

Net Present Value (NPV) – Project – A

Year	Annual Cash Flow ($)	Present Value factor at 8%	Present Value of Cash Flow ($)
1	52,000	0.92593	48,148.15
2	21,000	0.85734	18,004.12
3	20,000	0.79383	15,876.64
TOTAL			82,028.91

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $82,028.91 - $48,000

= $34,028.91

Net Present Value (NPV) – Project – B

Year	Annual Cash Flow ($)	Present Value factor at 8%	Present Value of Cash Flow ($)
1	48,000	0.92593	44,444.44
2	25,000	0.85734	21,433.47
3	26,000	0.79383	20,639.64
TOTAL			86,517.55

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $86,517.55 - $48,000

= $38,517.55

Requirement (b)(2) - The project to be chosen based on the net present value method

“PROJECT B” should be choses based on the net present value method, since it has the higher NPV of $38,517.55

Requirement - (c)

“Net present value method”. The Net present value method gives more confidence since it considers the time value of money and taken account of all the yearly cash flows.

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.