Question #191854

Org Pvt. Ltd. is considering two mutually exclusive capital investments. The projectâ€™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 projectâ€™s cost of capital was 10%, which project should be selected using the NPV criteria?

b. What is each projectâ€™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%?

Expert's answer

(a)

Since NPV is more of Project B as compared to Project A, hence it is

advisable to accept Project B

(b)

(c)Calculating the regular payback period for Project A:

payback period

Thus, the payback period for Project A is 3.616 years or 3.62 years (rounded off).

Calculating the regular payback period for Project B:

Thus, the payback period for Project B is 2.0909 years or 2.09 years.

*The variable A*denotes the last year with a negative cumulative cash flow;*The variable B*denotes the value without negative symbol cumulative net cash flow at the end of year*A*; and*The variable C*denotes the gross cash flow during the year following year A

(d)

where,

PV Factor=1/(1+Cost of capital)^number of years

Discounted cash flow=Cash flow*PV factor

Present Value of total cash inflows=Sum of all the cash inflows

Profitability Index

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