Question

Q) A firm has a WACC of 10.58% and is deciding between two mutually exclusive projects. Project A has an initial investment of $60.79. The additional cash flows for project A are: year 1 = $15.60, year 2 = $36.71, year 3 = $41.74. Project B has an initial investment of $73.28. The cash flows for project B are: year 1 = $59.23, year 2 = $49.61, year 3 = $23.70. Calculate the Following:

-Payback Period for Project A:

-Payback Period for Project B:

-NPV for Project A:

-NPV for Project B:

Answer 1

1.Project A

Cumulative cash flow in year 1= $15.60

Cumulative cash flow in year 2= $52.31

Payback period= full years until recovery + unrecovered cost at the start of the year/ cash flow during the year

= 2 years + ($60.79 - $52.31)/ $41.74

= 2 years + $8.48/ $41.74

= 2 years + 0.20

= 2.20 years.

2.Project B

Payback period= full years until recovery + unrecovered cost at the start of the year/ cash flow during the year

= 1 year + ($73.28 - $59.23)/ $49.61

= 1 year + $14.05/ $49.61

= 1 year + 0.28

= 1.28 years.

3.Project A

Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$60.79. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the weighted average cost of capital of 10.58%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 10.58% weighted average cost of capital is $14.21.

4.Project B

Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$73.28. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the weighted average cost of capital of 10.58%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 10.58% weighted average cost of capital is $38.38.

In case of any query, kindly comment on the solution.