Question

Question
We have two investment projects A&B. Both projects cost $250, and we require a 15% return of the two
investments.
Year A B
1 $100 $100
2 $100 $200
3 $100 0
4 $100 0
a) Based on the payback period rule, which project would you pick? Explain.
b) Based on the NPV rule, which project would you pick? Explain.
c) Do a) and b) give you the same conclusion? If not, why? Please elaborate.
d) What other methods can you use to evaluate proposed investments? Please explain.

Answer 1

					Cumulative cash flow					present value
	year	Project A	Project B		Project A	Project B		PVIF @ 15%		Project A	Project B
	0	-250	-250		-250	-250		1.0000		(250.00)	(250.00)
	1	100	100		-150	-150		0.8696		86.96	86.96
	2	100	200		-50	50		0.7561		75.61	151.23
	3	100	0		50	50		0.6575		65.75	-
	4	100	0		150	50		0.5718		57.18	-
										35.50	(11.81)
ans a)	Payback period A =			=2+(50/100)
				2.5	year
	Payback period B =			=1+(150/200)
				1.75	year
	since payback of project B is lower therefore B should be selected
ans b)	NPV A =	35.50
	NPV B =	(11.81)
	since NPV of A is positive and higher than B therefore based on NPV project A should be selected.
ans C)	a and b does not provide same conclusion. This is because Payback period does not take into account time value of money while NPV does
ans d)	NPV should be better approach to evaluate the project. As NPV take into account time value of money.
	therefore project A should be selected.