Question

5. Consider the following two mutually exclusive projects: Year Cash Flow (A) Cash Flow (B) -$300,000 -$40,000 $10,000 $17,000 $60,000 $14,000 $60,000 $20,000 $400,000 $10,500 You require a 15% return on both investments. a. What is the payback period of each of the project? (6 points) b. What is the discounted payback period of each of the project? (6 points) c. What is the NPV of each of the project? (6 points) d. What is the profitability index (PI) of each of the project? (6 points) e. Which project should you choose based on the above information? Give one scenario that it makes sense not to choose your project based on NPV. (5 points)

Answer 1

Answer marked in yellow. Since the size of image file exceeding the approved limit. Hence, pasted below.

Year	Cash Flow A	Cash Flow B
0	$              (300,000)	$                                     (40,000)
1	$                  10,000	$                                       17,000
2	$                  60,000	$                                       14,000
3	$                  60,000	$                                       20,000
4	$               400,000	$                                       10,500
Answer to a
Payback period is the period by which investment will be recovered
Assuming cash flow for each year is spread equally over the months.
	Recovery Amount/Years		Recovery Amount/Years
Recovery Years	Cash Flow A	No of Years	Cash Flow B	No of Years
1	$                  10,000	1	$          17,000	1
2	$                  60,000	1	$          14,000	1
3	$                  60,000	1	$            9,000	0.86
4	$               170,000	0.425
Total	$               300,000	3.425	$         40,000	2.857
Answer to b
Discounted Rate	15%
Formula for Discounted Cash Flow		Cash Flow Amount/(1+Discounted Rate)^n
		Where n is the number of years
	Recovery Amount/Years		Recovery Amount/Years
Recovery Years	Cash Flow A	Discounted Cash Flow@15%	Amount	No of Years
1	$                  10,000	$                                         8,696	$            8,696	1
2	$                  60,000	$                                       45,369	$          45,369	1
3	$                  60,000	$                                       39,451	$          39,451	1
4	$               400,000	$                                     228,701	$       206,485	0.90
Total	$               530,000	$                                     322,217	$       300,000	3.90
	Recovery Amount/Years		Recovery Amount/Years
Recovery Years	Cash Flow B	Discounted Cash Flow@15%	Amount	No of Years
1	$                  17,000	$                                       14,783	$          14,783	1
2	$                  14,000	$                                       10,586	$          10,586	1
3	$                  20,000	$                                       13,150	$          13,150	1
4	$                  10,500	$                                         6,003	$            1,481	0.25
Total	$                 61,500	$                                       44,522	$         40,000	3.25
Answer to c
Formula for NPV is same as given in above tablle for discounted Cash Flow
	Recovery Amount/Years
Recovery Years	Cash Flow A	Discounted Cash Flow@15%
1	$                  10,000	$                                         8,696
2	$                  60,000	$                                       45,369
3	$                  60,000	$                                       39,451
4	$               400,000	$                                     228,701
Total	$               530,000	$                                     322,217
	Recovery Amount/Years
Recovery Years	Cash Flow B	Discounted Cash Flow@15%
1	$                  17,000	$                                       14,783
2	$                  14,000	$                                       10,586
3	$                  20,000	$                                       13,150
4	$                  10,500	$                                         6,003
Total	$                 61,500	$                                       44,522
Answer to d
Profitability Index	Present Value of Future Cash Flows / Initial Investments
	By Profitabiility Index whether to invest in the project or not can be determined.
	This should always be > 1
	Cash Flow A	Cash Flow B
Present Value of Future cash Flows	$               322,217	$                                       44,522
Initial Investment	$               300,000	$                                       40,000
Profitability Index	$                      1.07	$                                           1.11
Answer to e
Profitability Index should be choosen as the basis of selecting the project.
Cash Flow B / Project B should be choosen as it profitability Index is higher comparing to project A
NPV of different projects vary and projects having different amount of invesments where one project is expecting big investment and other project expecting small investment can't be made compared based on NPV.