Question

Compare the results of the three (3) methods by quality of information for decision making. Using what you have learned about the three (3) methods, identify the best project by the criteria of long term increase in value. (You do not need to do further research.) Convey your understanding of the Time Value of Money principles used or not used in the three (3) methods. Review the video titled "NPV, IRR, MIRR for Mac and PC Excel" (located at https://www.youtube.com/watch?v=C7CryVgFbBc and previously listed in Week 4) to help you understand the foundational concepts:

Scenario Information:

Assume that two gas stations are for sale with the following cash flows: CF1 is the Cash Flow in the first year, and CF2 is the Cash Flow in the second year. This is the timeline and data used in calculating the Payback Period, Net Present Value, and Internal Rate of Return. The calculations are done for you. Your task is to select the best project and explain your decision. The methods are presented and the decision each indicates is given below.

Investment	Sales Price	CF1	CF2
Gas Station A	$50,000	$0	$100,000
Gas Station B	$50,000	$50,000	$25,000

Three (3) Capital Budgeting Methods are presented:

1. Payback Period: Gas Station A is paid back in 2 years: CF1 in year 1, and CF2 in year 2. Gas Station B is paid back in one (1) year. According to the payback period, when given the choice between two mutually exclusive projects, the investment paid back in the shortest time is selected.
2. Net Present Value: Consider the gas station example above under the NPV method, and a discount rate of 10%:
   • NPV _{gas station A} = $100,000/(1+.10)² - $50,000 = $32,644
   • NPV _{gas station B} = $50,000/(1+.10) + $25,000/(1+.10)² - $50,000 = $16,115
3. Internal Rate of Return: Assuming 10% is the cost of funds. The IRR for Station A is 41.421%.; for Station B, 36.602.

Summary of the Three (3) Methods:

• Gas Station B should be selected, as the investment is returned in 1 period rather than 2 periods required for Gas Station A.
• Under the NPV criteria, however, the decision favors gas station A, as it has the higher net present value. NPV is a measure of the value of the investment.
• The IRR method favors Gas Station A, as it has a higher return, exceeding the cost of funds (10%) by the highest return.

Answer 1

AS PER PAYBACK PERIOD METHOD :

PAYBACK PERIOD method is the time taken to recover the initial investment i.e  time required to earn back the amount invested.

Payback period of GAS STATION A is 2 years

Payback period of GAS STATION B is 1 year

so as per payback period method we choose GAS STATION A because we get the initial investment with in 1 year.

AS PER NET PRESENT VALUE METHOD :

Net present value  is the difference between the present value of cash inflows and the present value of cash outflows over a period of time.

NPV OF GAS STATION A =$32644

NPV OF GAS STATION B =$16115

As per NPV method we choose GAS STATION A because NPV of GAS STATION A is more then NPV of GAS STATION B.

AS PER IRR METHOD :

IRR is the discounting rate at which the NPV of the project becomes zero i.e it is the interest rate up to which rate we can borrow money to invest in a project.

IRR of the GAS STATION A = 41.421%

IRR of the GAS STATION B= 36.602%

As per IRR method it is better to choose GAS STATION A.

Therefore from above explanation it is better to invest in GAS STATION A.