You are the senior manager at the Poeing Aircraft and have been authorized to sp

Question

You are the senior manager at the Poeing Aircraft and have been authorized to spend up to $200,000 for projects. The two projects you are considering have the following characteristics:

Project A: Initial investment of $100,000. Cash flow of $100,000 at year 1 and $100,000 at year 2. This is a market expansion project, where the required rate of return is 20 percent.

Project B : Initial investment of $200,000. Cash flow of $200,000 at year 1 and $111,000 at year 2. This is a new product development project, where the required rate of return is 20 percent.

Assume the corporate discount rate is 10 percent. Please offer your recommendation, backed by your analysis of payback period, IRR, PI, NPV.

Explanation / Answer

Profitability Index = Present Values of Future cash flows/Initial Investment

IRR is the rate which makes NPV = 0

NPV = Present Value of Future cash flows - Initial Investment

Payback Period = It is the period within which the inital invested amount is recoverd back in a particular project :

PV of cash Flows of Project A  

As per my analysis, Project A should be accepted as it is not only having higher Profitability Index but also higher IRR as compared to project B.

Details Project A Project B -100000 -200000 Year1 100000 200000 Year2 100000 111000 Required rate of return 20% 20%

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