Question

P10–24 All techniques: Decision 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 (CF0)	−$60,000	−$100,000	−$110,000
Cash inflows (CFt), t = 1 to 5	20,000	31,500	32,500

1. Calculate the net present value (NPV) of each project, assuming that the firm has a cost of capital equal to 13%.
2. Calculate the internal rate of return (IRR) for each project.
3. Summarize the preferences dictated by each measure and indicate which project you would recommend. Explain why.

Answer 1

a.Project A

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

• Press the CF button.
• CF0= -$60,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the cost of capital of 13%.
• Press the down arrow and CPT buttons to get the net present value.

Present value of cash flows at 13% cost of capital is $10,344.63.

Project B

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

• Press the CF button.
• CF0= -$100,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the cost of capital of 13%.
• Press the down arrow and CPT buttons to get the net present value.

Present value of cash flows at 13% cost of capital is $10,792.78.

Project C

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

• Press the CF button.
• CF0= -$110,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the cost of capital of 13%.
• Press the down arrow and CPT buttons to get the net present value.

Present value of cash flows at 13% cost of capital is $4,3100.02.

b.Project A

Internal rate of return is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$60,000. It is entered with 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 IRR and CPT button to get the IRR of the project.

The IRR of the project is 19.86%.

Project B

Internal rate of return is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$100,000. It is entered with 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 IRR and CPT button to get the IRR of the project.

The IRR of the project is 17.34%.

Project C

Internal rate of return is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$110,000. It is entered with 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 IRR and CPT button to get the IRR of the project.

The IRR of the project is 14.59%.

c.Ranking of preference of projects by NPV
1.Proejct B

2.Project A

3.Project C

Ranking of preference of projects by NPV
1.Project A

2.Project B

3.Project C

d.I would recommend selecting project B since it has the highest net present value.

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