Org Pvt. Ltd. is considering two mutually exclusive capital investments. The project’s expected net cash flows are as follows:
Expected Cash Flows Year Project A Project B
0 -400 -575
1 95 150
2 110 200
3 118 250
4 125 275
5 140 230
6 150 180
a. If you were told that each project’s cost of capital was 10%, which project should be selected using the NPV criteria?
b. What is each project’s IRR?
c. What is the regular payback period for these two projects? d. What is the profitability index for each project if the cost of capital is 12%?
Capital budgeting indicates the evaluation of the profitability of possible investments and projects that can enhance the revenue of the company.
Computation of the NPV, IRR, payback period, and the profitability index:
(a) As per the NPV criteria, project B should be selected because the NPV of project B is higher than the NPV of project A.
(b) The IRR of project A and project B is 19.12% and 27.54% respectively.
It is computed by using the following method:
(c) The regular payback period of project A and project B is 3.62 years and 2.90 years respectively.
(d) The profitability index of project A and project B is 1.23 and 1.51 respectively.