The Alexis Industries is analyzing two potential inventory expansion projects. O

Question

The Alexis Industries is analyzing two potential inventory expansion projects. Option B is more costly and provides larger cash inflows. Project A and Project B are mutually-exclusive projects. Inventory decision are made every three years. Due to a soft economy, Alexis' required return is only 6.08. Results for option A are provided. Complete the analysis for Option B and identify the project that should be selected. Show work to get partial credit is situations where you have incorrect final answer. Payback Method Discounted Payback Net Present value Profitability Index Internal Rate of Return Modified Internal Rate of Return Which project should be chosen by Alexis Industries? 

Explanation / Answer

Since, there are multiple parts to the question, the first four parts have been answered.

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Part A)

To determine the payback period, we need to calculate the cumulative cash flows as follows:

Based on the calculations above, it can be seen that the initial value of $39,000 will get recovered between Year 1 and Year 2 (refer to cumulative cash flows column). The formula for calculating payback period is given below:

Payback Period = Years upto which Partial Recovery is Made + Balance/Cash Flow of the Year in which Full Recovery is Made

Payback Period = 1 + (39,000 - 21,000)/19,000 = 1.95 Years

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Part B)

To determine the discounted payback period, we need to calculate the discounted cash flows and cumulative discounted cash as follows:

Based on the calculations above, it can be seen that the initial value of $39,000 will get recovered between Year 2 and Year 3 (refer to cumulative discounted cash flows column). The formula for calculating discounted payback period is given below:

Discounted Payback Period = Years upto which Partial Recovery is Made + Balance/Discounted Cash Flow of the Year in which Full Recovery is Made

Discounted Payback Period = 2 + (39,000 - 36,721.25)/15,113.15 = 2.15 Years

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Part C)

Net present value is the difference between the present value of cash inflows and present value of cash outflows. It can be calculated with the use of following formula:

NPV = Cash Flow Year 0 + Cash Flow Year 1/(1+Required Return)^1 + Cash Flow Year 2/(1+Required Return)^2 + Cash Flow Year 3/(1+Required Return)^3

Using the information provided in the question, we get,

NPV = -39,000 + 21,000/(1+6%)^1 + 19,000/(1+6%)^2 + 18,000/(1+6%)^3 = $12,834.40 or $12,834

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Part D)

The profitability index can be calculated with the use of following formula:

Profitability Index = Present Value of Cash Inflows/Initial Investment

where Present Value of Cash Inflows = Cash Flow Year 1/(1+Required Return)^1 + Cash Flow Year 2/(1+Required Return)^2 + Cash Flow Year 3/(1+Required Return)^3 = 21,000/(1+6%)^1 + 19,000/(1+6%)^2 + 18,000/(1+6%)^3 = $51,834.40

Profitability Index = 51,834.40/39,000 = 1.33

Year Cash Inflow Cumulative Cash Flow 1 21,000 21,000 2 19,000 40,000 3 18,000 58,000

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