Question

Trade Wind's Enterprises Ltd (Tw) has £20 two capital investment projects, which have cash flows as shown below. ,000 that it can invest in any or all of the Comparison of Project Cash Flows* Year of Cash Flow Year 0 Year I Year 3 Type of Cash Flow Project Year 2 (E10 000) Investment Revenue Operating expenses Investment Revenue Operating expenses A. £10000 11,000 30 000 4 889 15 555 B. (10 000) £5 000 10000 2222 15 555 5555 2 222 TW's "The investment will be depreciated to zero on a straight-line basis for tax purposes. marginal corporate tax rate on taxable income is 40% None of the projects will have any salvage alue at the end of their respective lives. For purposes of analysis, it should be assumed that all cash flows occur at the end of the year in question. Rank TW' s two projects according to the following three commonly used capital budgeting criteria: . Payback period. .Accounting return on investment (ROI). . Net present value (NPV), assuming alternately a 10% discount rate (Present Value and Annuity tables are provided) If the projects are independent of each other, which should be accepted? If they are mutually exclusive (i.e, one and only one can be accepted), which one is best?

Answer 1

Ranking:

As per payback period project B is first rank and project A is second rank

As per ROI project A is first rank and project B is second rank

As per NPV project A is first rank and project B is second rank

independent of each other then both can be accepted as NPV is positive and if it is mutually exclusive Project A is best