1. Cummings Products Company\'s cost of capital is 15% and the company is consid
ID: 2708151 • Letter: 1
Question
1. Cummings Products Company's cost of capital is 15% and the company is considering two mutually exclusive projects. The projects' expected cash flows are as follows:
0
1
2
3
4
5
6
Project A
-550
160
160
160
160
160
160
Project B
-875
450
350
250
150
50
0
a. What are the two projects
0
1
2
3
4
5
6
Project A
-550
160
160
160
160
160
160
Project B
-875
450
350
250
150
50
0
Cummings Products Company's cost of capital is 15% and the company is considering two mutually exclusive projects. The projects' expected cash flows are as follows: What are the wo projects' payback periods? What are the two projects' IRRs? What are the two projects' NPVs? Which project should you choose?Explanation / Answer
Hi,
Please find the answer as follows:
Part A:
Payback Period = Initial Investment/Annual Cash Inflows
Project A = 550/160 = 3.4375 or 3.44 Years
Project B = Out of 875 worth of initial investment 450 (Year 1) + 350 (Year 2) = 800 will get recovered in the first 2 Years. Remaining 75 will get recovered between Year 3 and Year 4
Payback Period = 2 + 75/250 = 2.3 Years
Part B:
Project A:
To calculate IRR, you need to put the value of NPV as 0 and solve for IRR as follows:
NPV = 0 = -550 + 160/(1+r)^1 + 160/(1+r)^2 + 160/(1+r)^3 + 160/(1+r)^4 + 160/(1+r)^5 + 160/(1+r)^6 = 18.68% or 18.68%
IRR = 16.20%
Project B:
To calculate IRR, you need to put the value of NPV as 0 and solve for IRR as follows:
NPV = 0 = -875 + 450/(1+r)^1 + 350/(1+r)^2 + 250/(1+r)^3 + 150/(1+r)^4 + 50/(1+r)^5 + 0/(1+r)^6 = 18.62%
IRR = 18.62%
Part C:
Project A = -550 + 160/(1+.15)^1 + 160/(1+.15)^2 + 160/(1+.15)^3 + 160/(1+.15)^4 + 160/(1+.15^5 + 160/(1+.15)^6 = 55.52
Project B = -875 + 450/(1+.15)^1 + 350/(1+.15)^2 + 250/(1+.15)^3 + 150/(1+.15)^4 + 50/(1+.15)^5 + 0/(1+.15)^6 = 55.96
Part D:
Project B should be selected.
Thanks.
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