Question

Giant Machinery Ltd is considering to invest in one of the two following Projects to buy a new equipment. Each project will last 5 years and have no salvage value at the end. The company’s required rate of return for all investment projects is 9%. The cash flows of the projects are provided below. Project 1 Project 2 Cost $175,000 $185,000 Future Cash Flows Year 1 Year 2 Year 3 Year 4 Year 5 76,000 83,000 67,000 65,000 55,000 87,000 78,000 69,000 65,000 57,000 Required: a) Identify which project should the company accept based on NPV method. (Note: Please round up the result of each calculation of PV to 2 decimal places only for simplification) b) Identify which project should the company accept based on simple pay back method if the payback criteria is maximum 2 years. c) Which project Giant Machinery should choose if two methods are in conflict.

Answer 1

Based on NPV method Project 1 should be selected as it has higher NPV compared to project 2

Based on Simple payback period method Project 1 should be selected as it has lower payback period compared to project 2

If two methods are in conflict then company should chose project with highest NPV as it is the most profitable project.