You are considering the following two mutually exclusive projects. Both projects
ID: 2745134 • Letter: Y
Question
You are considering the following two mutually exclusive projects. Both projects will be depreciated using straight-line depreciation to a zero book value over the life of the project. Neither project has any salvage value
Year cash flow Year cash flow
0 -$45,000 0 -$40,000
1 $17,500 1 $8,200
2 $18,000 2 $14,600
3 $22,500 3 $36,800
Project A Project B
Required rate of return 8% 12%
required payback period 2years 2years
Required accounting return 8.5% 9.5%
a. What is the NPV for each of the projects? Which project should be accepted if NPV method is applied? Explain why.
b.What is the IRR for each of the projects? Which project should be accepted if IRR method is applied? Explain why.
c. What is the payback period for each of the projects? Which project should be accepted if payback period method is applied? Explain why.
d. What is the discounted payback period for each of the projects? Which project should be accepted if discounted payback period method is applied? Explain why.
e. What is the profitability index for each of the projects? Which project should be accepted if profitability index method is applied? Explain why.
f. What is the average accounting return (AAR) for each of the projects, assuming that cash flows occurring after year 0 are net income? Which project should be accepted if AAR method is applied? Also, assume that the target AAR is 10%.
g. Define and find the crossover rate.
h. Sketch the NPV profile. Plot all the relevant coordinates (i.e., the points on the x and y axis; and the cross-over rate) on the graph.
Explanation / Answer
a. Based on NPV Project B should be chosen since it has a higher NPV value
b. Based on IRR Project B should be chosen since it has a higher iRR
c. Payback for A = 2 + (45000 - 17500 - 18000)/22500 = 2.42 years
Packback for B = 2 + (40000 - 8200 - 14600)/36800 = 2.47
Based on Payback project A should be chosen since the payback is less and it would take lesser time to recover the money
8% 12% Project A Project A PV Project B Project B PV 0 -45000 -45000 -40000 -40000 1 17500 16203.70 8200 7321.43 2 18000 15432.10 14600 11639.03 3 22500 17861.23 36800 26193.51 NPV 4497.03 5153.97 IRR 13.22% 17.79%Related Questions
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