Assume you have 3 projects with the following cash flows, and the projects are i
ID: 2783669 • Letter: A
Question
Assume you have 3 projects with the following cash flows, and the projects are independent. The cost of capital (the WACC) is 3% and the required rate of return is 20%. To make the investment decisions, how many investment decision rules do you have for each project? Discuss briefly about each rule (you need to discuss NPV, IRR, Payback Period, and Profitability Index for sure). 2) Which project/projects should you choose based on these 4 decision rules ? Explain and show all calculations to support your answers.
Year
0
1
2
3
4
Project 1
-250
100
100
150
220
Project 2
-825
0
0
7000
-6500
Project 3
-20
40
60
80
-245
Year
0
1
2
3
4
Project 1
-250
100
100
150
220
Project 2
-825
0
0
7000
-6500
Project 3
-20
40
60
80
-245
Explanation / Answer
NPV = PRESENT VALUE OF CASH INFLOWS - INITIAL INVESTMENT
to find NPV, we multiply the cash inflows with the present value interest factor for 3%, which is the WACC
project1 NPV= ( 100 * 0.971+100*0.943+150*0.915+220*0.889) -250= 524.23-250=274.23
project2 NPV= (0*0.971+0*0.943+7000 *0.915-6500*0.889) -825= 626.5-825= -198.5
project3 NPV=(40*0.971+60*0.943+80* 0.915-245*0.889)-20 = -49.185-20= -69.185
decision is accept project1
PROFITABILITY INDEX= PRESENT VALUE OF CASH INFLOWS/INITIAL INVESTMENT
project 1 PI= 524.23/250= 2.10
project2 PI= 626.5/825= 0.76
project3 PI= -49.185/20= -2.46
decision is accept project1
PAYBACK PERIOD
project 1 : 200 is recovered in2 years. the balance 250-200 , that is 50 is recovered in the third year.The fraction of a year in which 50 is recovered= 50/150= 0.33. So payback period=2+0.33=2.33years
project2. 7000 is recovered in the third year. fraction of a year in which 825 is recovered= 825/7000= 0.18. So payback period = 2+0.18= 2.18 years
project 3=40 is recovered in the 1st year. fraction of a year in which 20 is recovered is 20/40= 0.5 or half yearr
decision is project3 whoich has shortest payback period of half year
IRR IS THE RATE OF RETURN THAT MAKES npv=0
IRR OF project1
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.