Question

Marian Ltd is considering two mutually - exclusive projects with the following details:

Project A Initial investment Le 450,000

Scrape value in year 5 Le 20,000 Year 1 2 3 4 5

( Le000) ( Le000 ) (Le000) (Le000) ( Le000)

Annual Cash flows 200 150 100 100 100

Project B:

Initial investment Le 100,000

Scrape value in year 5 Le10,000

Year 1 2 3 4 5

( Le000 ) ( Le000 ) ( Le000) ( Le000) ( Le000 )

Annual Cash flows 50 40 30 20 20

Assuming that the initial investment is at the start of the project and the annual cash flows accrue evenly over the year. Calculate the discounted payback for both projects if the relevant cost of capital is 10%.

NOTE: Contacted the lecturer. Got feedback that this is all to the question as there is an indication of ANNUAL FLOWS for both project A and B. Kindly assist.

Answer 1

Discounted payback period with less time has to be selected because of retaining the initial cost of investment in short period.

First of all we have to find the discounted cashflows for each project A & B

Year1 present value factor=1/(1+10%)

Year2 present value factor=1/(1+10%)^2 and it goes on like that Year 3 present value factor=1/(1+10%)^5

To get the discounted cashflows, multiply cashflows with present value factor. Please find the discounted cashflows in the below table.

	project A	project B
	Cashflows	Present value factor@10%	Discounted cashflows	Cashflows	Present value factor@10%	Discounted cashflows
Year1	200000	0.909090909	181818.2	50000	0.909090909	45454.5
Year2	150000	0.826446281	123966.9	40000	0.826446281	33057.9
Year3	100000	0.751314801	75131.5	30000	0.751314801	22539.4
Year4	100000	0.683013455	68301.3	20000	0.683013455	13660.3
Year5	120000	0.620921323	74510.6	30000	0.620921323	18627.6

Discounted payback period  of project A: They receives 449,217.9 in 4 years and receives the remaining 782.05 (450000-449217.9) in 5th year.

In 5th year=782.05/74510.6=0.01

In total it takes 4.01 years to retain the investment of 450,000. hence, the discounted payback period=4.01 years

Discounted payback period  of project B:They receives 78,512.4 in 2 years and receives the remaining 21487.6 (100000-78512.4) in 3rd year.

In 3rd year=21487.6/22539.4=0.95

In total it takes 2.95 years to retain the investment of 100,000. hence, the discounted payback period=2.95 years

Project B has less payback period, hence project B has to be selected