Question

among mutually exclusive investments Pound Industries is attempting to select the best of three mutually exclusive projects. The initial investment and after-tax cash inflows associated with these projects are shown in the following table.

Cash flows	Project A		Project B		Project C
Initial investment (CF)	$120 comma 000120,000		$170 comma 000170,000		$170 comma 000170,000
Cash inflows (CF), tequals=1 to 5	$40 comma 00040,000		$51 comma 50051,500		$53 comma 00053,000

a. Calculate the payback period for each project.

b. Calculate the net present value (NPV) of each project, assuming that the firm has a cost of capital equal to

1414 %.

c. Calculate the internal rate of return (IRR) for each project.

d.

Indicate

which project you would recommend.

Answer 1

Pay back period, refers to the time taken for the project to collect the investment. Thus the formula to compute it is ......

Payback period = Investment / Annual cash inflow.

	Proj - A	Proj - B	Proj - C
Investment	120000	170000	170000
Annual cash flow	40000	51500	53000
Pay back = Inv / CF	3 Years	3.3 Years	3.21 years

Question - b

		Project - A		Project - B		Project - C
Year	DF (14%)	CF	PV	CF	PV	CF	PV
0	1	-120000	-120000	-170000	-170000	-170000	-170000
1	0.877193	40000	35087.72	51500	45175.44	53000	46491.23
2	0.769468	40000	30778.7	51500	39627.58	53000	40781.78
3	0.674972	40000	26998.86	51500	34761.03	53000	35773.49
4	0.59208	40000	23683.21	51500	30492.13	53000	31380.25
5	0.519369	40000	20774.75	51500	26747.49	53000	27526.54
		NPV(A)	17323.24	NPV(B)	6803.67	NPV(C)	11953.29

In the above table ......... Year and DF columns are common for all projects.

DF = Discounting factors can be taken from present value tables, where value to be taken at 14%. Otherwise, using a standard calculator ......... 1/1.14 = will give Year - 1 discounting factor. There after just press " = " to get the discounting factors for other years.

To get PV ( present value), just multiply the CF with DF. Note that CF values are already given in the question itself. Investment shall be taken as negative cash flow.

Question - c

Computing IRR ............. Using excel function

Use the syntax ............ = IRR(-INVESTMENT, CF1,CF2,CF3,CF4,CF5)

PROJECT - A ............ = IRR (-120000.40000,40000,40000,40000,40000) = 19.86 %

PROJECT - B .......... = IRR(-170000,51500,51500,51500,51500,51500) = 15.65 %

PROJECT - C ........... =IRR(-170000,53000,53000,53000,53000,53000) = 18.89 %