Question

2 POTENTIAL CAPITAL PROJECTS HAVE THE FOLLOWING ESTIMATED CASHFLOWS

                                                            PROJECT 1                            PROJECT 2

YEAR                                                                         CASHFLOW                          CASHFLOW

   1                                                                               $95,000                                   $112,000

   2                                                                               $150,000                                 $95,000

   3                                                                               $1,000                                     $85,000

   4                                                                               $12,000                                   $65,000

   5                                                                               $45,000                                   $10,000

   6                                                                               $198,000                                 $15,000

BOTH PROJECTS HAVE A COST OF $300,000. THE COST OF CAPITAL IS 9.5%

A. CALCULATE THE PAYBACK FOR EACH PROJECT. STATE IF THE PROJECT IS ACCEPTABLE UNDER PAYBACK AND WHY.

B. CALCULATE THE NPV FOR EACH PROJECT. STATE IF THE PROJECT IS ACCEPTABLE UNDER NPV AND WHY.

C. CALCULATE THE IRR FOR EACH PROJECT. STATE IF THE PROJECT IS ACCEPTABLE UNDER IRR AND WHY.

D. CALCULATE THE PI FOR EACH PROJECT. STATE IF THE PROJECT IS ACCEPTABLE UNDER PI AND WHY.

E. STATE WHICH IS THE BEST PROJECT OVERALL AND WHY.

Answer 1

A)

If projects are independent , Under payback both projects are acceptable as both projects have payback < cut off period. If projects are mutually exclusive Project 2 will be accepted as it has a lower payback period.

b)

If projects are independent, both projects will be accepted under NPV rule because NPV > 0 for both projects. If projects are mutually exclusive,then Project 1 will be accepted due to higher NPV

c)

If projects are independent, both projects will be accepted as their IRR> Cost of capital. If mutually exclusive, Project 1 will be chosen due to higher IRR.

d)

If projects are independent, using PI rule both projects will be accepted as their PI >1 . If mutually exclusive, then Project 1 will be accepted due to higher PI.

e)

Overall the best project is Project 1 as it has better NPV, IRR and PI than project 2

Formulae