Suppose your firm is considering two mutually exclusive, required projects with
ID: 2719736 • Letter: S
Question
Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown below. The required rate of return on projects of both of their risk class is 11 percent, and that the maximum allowable payback and discounted payback statistic for the projects are 2 and 3 years, respectively. Time: 0 1 2 3 Project A Cash Flow -28,000 18,000 38,000 9,000 Project B Cash Flow -38,000 18,000 28,000 58,000 Use the PI decision rule to evaluate these projects; which one(s) should be accepted or rejected?
Explanation / Answer
Project A Details Year 0 Year 1 Year 2 Year 3 Cash Flows (28,000) 18,000 38,000 9,000 Discount factor @11% 1 0.9009 0.8116 0.7312 PV of Cash flows (28,000) 16,216 30,842 6,581 PV of Cash InFlows 53,639 PV of Cash Outflow 28,000 PI =PV of Cash Inflows/Outflow= 1.92 Pay Back Years 1.264 Discounted Payback Years 1.382 Project B Details Year 0 Year 1 Year 2 Year 3 Cash Flows (38,000) 18,000 28,000 58,000 Discount factor @11% 1 0.9009 0.8116 0.7312 PV of Cash flows (38,000) 16,216 22,725 42,409 PV of Cash InFlows 81,351 PV of Cash Outflow 38,000 PI =PV of Cash Inflows/Outflow= 2.14 Pay Back Years 1.720 Discounted Payback Years 2.960 Both Projects are acceptable in Payback and dicounted payback criteria. However Project B has higher PI ratio than Project A. So on PI basis Project B should be accepted.
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