Hi, can you please help me with this? I have tried but am not sureif I am correc

Question

Hi, can you please help me with this? I have tried but am not sureif I am correct.

Moody Vitamin Company is considering two investments, both of whichcost $ $10,000. The cash flows are as follows:
Year     Project A    Project B
1            $12,000      $10,000
2            $ 8,000       $ 6,000
3            $ 6,000       $ 16,000

a. Which of the two projects should be chosen based on the paybackmethod?
b. Which of the two projects should be chosen based on the netpresent value method? (Assume a cost of capital of 10%).

For the A part I would choose project B as the answer. For the Bpart I would choose B also because the amount of money made isgreat than with project A.

Explanation / Answer

Answer:

a. Which of the twoprojects should be chosen based on the payback method?

Initial cost is $10,000,which we have to cover through a project, and have to calculate thepayback period as shown below:

ProjectA:

In year 1, $12,000 will becovered, but we have to cover only $10,000 so,

Payback = $10,000 /$12,000

Payback = 0.8333years or 0.8333*12 = 10 months

ProjectB:

In year 1, $10,000 will becovered, and we also have to cover $10,000 so,

Payback = $10,000 /$10,000

Payback = 1 yearor 1*12 = 12 months

b. Which of the twoprojects should be chosen based on the net present value method?(Assume a cost of capital of 10%).

ProjectA:

We know that net presentvalue is calculated as following:

NPV = -Io+ CFt / (1+r) t

Here,

-Io is initialinvestment and it is an outflow so it is considered with negativesign, and CFt is the cash flows up to time period (t),and r is the interest rate of cost of capital.

NPV = -Io+ CFt / (1+r) t

NPV = -$10,000 + $12,000 /(1+0.1) 1 + $8,000 / (1+0.1) 2 + $6,000 /(1+0.1) 3

NPV = -$10,000 + $12,000 /(1.1) 1 + $8,000 / (1.1) 2 + $6,000 / (1.1)3

NPV = -$10,000 + $12,000 /(1.1) + $8,000 / (1.21) + $6,000 / (1.331)

NPV = -$10,000 +$10,909.0909 + $6,611.5702 + $4,507.8888

NPV = -$10,000 +$22,028.5499

NPV = $12,028.5499or $12,028.55

ProjectB:

NPV = -Io+ CFt / (1+r) t

NPV = -$10,000 + $10,000 /(1+0.1) 1 + $6,000 / (1+0.1) 2 + $16,000 /(1+0.1) 3

NPV = -$10,000 + $10,000 /(1.1) 1 + $6,000 / (1.1) 2 + $16,000 / (1.1)3

NPV = -$10,000 + $10,000 /(1.1) + $6,000 / (1.21) + $16,000 / (1.331)

NPV = -$10,000 +$9,090.9091 + $4,958.6777 + $12,021.0368

NPV = -$10,000 +$26070.6236

NPV = $16,070.6236or $ 16,070.62

Conclusion:

Project A should beaccepted if payback period is keeping in mind, just because ittakes less time that is 10 months as compared to the payback periodof Project B which is 12 months. On the other hand, Project Bshould be accepted if the net present value profile is keeping inmind, because Project B has higher net present value that is$16,070.62 which is greater than Project A’s net presentvalue which comes out just $12,028.55.

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