The Computer Games Division of Entertainment, Inc. is considering two investment
ID: 2636384 • Letter: T
Question
The Computer Games Division of Entertainment, Inc. is considering two investment projects, each of which has an up-front expenditure of $30,000. You estimate that the cost of capital is 9 percent and that the investments will produce the following after-tax cash inflows:
Year
Project A
Project B
1
6,000
22,000
2
12,000
16,000
3
16,000
12,000
4
22,000
6,000
Prepare answers to the following questions. Please show your calculations.
1. What is the payback period for each of the projects?
What is the Net Present Value (NPV) for each of the projects?
3. If the two projects are independent and the cost of capital is 9 percent, which project or projects should
Entertainment, Inc. undertake?
4. If the two projects are mutually exclusive and the cost of capital is 9 percent, which project should
Entertainment, Inc. undertake? (Hint: With mutually exclusive projects
Year
Project A
Project B
1
6,000
22,000
2
12,000
16,000
3
16,000
12,000
4
22,000
6,000
Explanation / Answer
The formula to calculate payback period is:-
We need to calculate the cumulative net cash flow for each period and then use the following formula for payback period = A + [B/C]
A is the last period with a negative cumulative cash flow;
B is the absolute value of cumulative cash flow at the end of the period A;
C is the total cash flow during the period after A
Therefore, using the above formula we get the payback period for:
Project A = 2.75 years
Project B = 1.50 years
The formula to calculate NPV = -CF0 + CF1/(1 + r)1 +
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