Question

The following two projects of equal risk are mutually exclusive alternatives for expanding the firm’s capacity. The firm’s cost of capital is 15%. The cash flows for each project are given in the following table.

Year Project A Project B

0 210,000 20,000

1 15,000 12,000

2 30,000 10,500

3 32,000 9,500

4 425,000 8,200

Required:

a) Calculate each project’s payback period. Using the payback period criterion which project is preferable? b) Calculate the net present value for each project. Using the net present value criterion, which project is preferable? ) Calculate the internal rate of return for each project. Using the internal rate of return criterion, which project is preferable? (Calculate to the nearest percentage). d) Calculate the profitability index. Using the profitability index criterion which project is acceptable? e) Discuss any conflict in ranking that may exist between the four methods used and why the NPV is the best method.

Answer 1

As per rules I am answering the first 4 subparts of the question.

		Project A	Project B	Preference
a	Payback	3.31	1.76	B
b	NPV	89763.44	9309.07	A
c	IRR	26.90%	38.30%	B
d	PI	1.43	1.47	B

Project with lower payback is preferred. In case of NPV,IRR and PI we prefer the project with higher statistics.

Workings