Question

Yonan Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the shorter payback, some value may be forgone. How much value will be lost in this instance? Note that under some conditions choosing projects on the basis of the shorter payback will not cause value to be lost.

WACC: 8%

Year	0	1	2	3	4
CFS	-$1,100	$390	$390	$390	$390
CFL	-$2,200	$735	$735	$735	$735

		$42.68
		$40.12
		$38.80
		$36.44
		$34.72

Answer 1

Answer : There will be loss of value of $ 42.68

Calculated as

Pay back period S = $1100/$390 = 2.82 yrs

Pay back period of Project L = $2200/735 = 2.99 years

So Project S will be selected it has shorter pay back period

Calculation of Loss in Value

YEAR	CASH INFLOW	PV @ 10%	PRESENT VALUE
1 TO 4	$                  390	3.312100	$            1,291.72
			$            1,291.72
initial investment			$          (1,100.00)
npv			$                191.72
YEAR	CASH INFLOW	PV @ 10%	PRESENT VALUE
1 TO 4	$                  735	3.312100	$            2,434.39
			$            2,434.39
initial investment			$          (2,200.00)
npv			$                234.39
Loss in Value	= $191.72-$234.39	=	$                (42.67)

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