Question

X-treme Vitamin Company is considering two investments, both of which cost $11,000. The cash flows are as follows: Year Project A Project B 1 $ 15,000 $ 11,000 2 6,000 6,000 3 5,000 10,000 Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. a-1. Calculate the payback period for Project A and Project B. (Round your answers to 2 decimal places.) a-2. Which of the two projects should be chosen based on the payback method? Project A correct b-1. Calculate the net present value for Project A and Project B. Assume a cost of capital of 8 percent. (Do not round intermediate calculations and round your final answers to 2 decimal places.)

Answer 1

a-1

Project A
Year	Cash flow stream	Cumulative cash flow
0	-11000	-11000
1	15000	4000
2	6000	10000
3	5000	15000

Payback period is the time by which undiscounted cashflow cover the intial investment outlay

this is happening between year 0 and 1

therefore by interpolation payback period = 0 + (0-(-11000))/(4000-(-11000))

0.73 Years

Project B
Year	Cash flow stream	Cumulative cash flow
0	-11000	-11000
1	11000	0
2	6000	6000
3	10000	16000

Payback period is the time by which undiscounted cashflow cover the intial investment outlay

this is happening at the end of year 1

therefore payback period is:

1 Years

a-2

Choose Project B as it has smaller payback

b-1

Project A
Discount rate	8.000%
Year	0	1	2	3
Cash flow stream	-11000	15000	6000	5000
Discounting factor	1.000	1.080	1.166	1.260
Discounted cash flows project	-11000.000	13888.889	5144.033	3969.161
NPV = Sum of discounted cash flows
NPV Project A =	12002.08
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Project B
Discount rate	8.000%
Year	0	1	2	3
Cash flow stream	-11000	11000	6000	10000
Discounting factor	1.000	1.080	1.166	1.260
Discounted cash flows project	-11000.000	10185.185	5144.033	7938.322
NPV = Sum of discounted cash flows
NPV Project B =	12267.54
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor