Four managers of King Industries have proposed major investment projects. Shelia
ID: 2788049 • Letter: F
Question
Four managers of King Industries have proposed major investment projects. Shelia Stewart, the CFO is trying to select the best investment from among the four.
Each proposal involves an initial outlay of $150,000. Their cash flows follow:
Year Ralph Susie Tom Ulma
1 $ 30,000 $ 90,000 $ 45,000 $ -
2 37,500 52,500 45,000 $ -
3 37,500 45,000 45,000 67,500
4 67,500 - 45,000 97,500
5 82,500 - 45,000 127,500
Evaluate and rank each alternative based on a) payback period, b) net present value (use a 9% discount rate), and c) internal rate of return.
Be sure to show your work in an excel file!
Cost $150,000
Discount Rate 9%
a) What is the Payback Period for for each alternative?
Ralph
Susie
Tom
Ulma
Which alternative would you choose using the payback period?
b) What is the Net Present Value for each project using a 9% discount rate?
Ralph
Susie
Tom
Ulma
Which alternative would you choose using the NPV using a 9% discount rate?
c) What is the IRR for each Project?
Ralph
Susie
Tom
Ulma
Which alternative would you choose using the IRR?
Explanation / Answer
a)
Payback period = A + B/C
Where,
A = last period with a negative cumulative cash flow
B = absolute value of cumulative cash flow at the end of the period A
C = total cash flow during the period after A
Project Ralph:
Year
Cash Flow
Cumulative cash flow
0
$ (150,000)
$ (150,000)
1
$ 30,000
$ (120,000)
2
$ 37,500
$ (82,500)
3
$ 37,500
$ (45,000)
4
$ 67,500
$ 22,500
5
$ 82,500
$ 105,000
Payback period = 3 +$ 45,000/$ 67,500 = 3 + 0.67 = 3.67
Project Susie:
Year
Cash Flow
Cumulative cash flow
0
$ (150,000)
$ (150,000)
1
$ 90,000
$ (60,000)
2
$ 52,500
$ (7,500)
3
$ 45,000
$ 37,500
4
-
5
-
Payback period = 2 + $ 7,500/$ 45,000 = 2 + 0.17 = 2.17
Project: Tom
Year
Cash Flow
Cumulative cash flow
0
$ (150,000)
$ (150,000)
1
$ 45,000
$ (105,000)
2
$ 45,000
$ (60,000)
3
$ 45,000
$ (15,000)
4
$ 45,000
$ 30,000
5
$ 45,000
$ 75,000
Payback period = 3 + $ 15,000/$ 45,000 = 3 + 0.33 = 3.33
Project: Ulma
Year
Cash Flow
Cumulative cash flow
0
$ (150,000)
$ (150,000)
1
-
$ (150,000)
2
-
$ (150,000)
3
$ 67,500
$ (82,500)
4
$ 97,500
$ 15,000
5
$ 127,500
$ 142,500
Payback period = 3 + $ 82,500/$ 97,500 = 3 + 0.85 = 3.85
Project Susie should be selected as per payback period.
b)
Project Ralph:
Year
Cash Flow
Formula for PV Factor
PV Factor @ 9%
PV
0
$ (150,000)
1/(1+0.09)^0
1
$ (150,000)
1
$ 30,000
1/(1+0.09)^1
0.917431193
$ 27,523
2
$ 37,500
1/(1+0.09)^2
0.841679993
$ 31,563
3
$ 37,500
1/(1+0.09)^3
0.77218348
$ 28,957
4
$ 67,500
1/(1+0.09)^4
0.708425211
$ 47,819
5
$ 82,500
1/(1+0.09)^5
0.649931386
$ 53,619
NPV
$ 39,481
Project Susie:
Year
Cash Flow
Formula for PV Factor
PV Factor @ 9%
PV
0
$ (150,000)
1/(1+0.09)^0
1
$ (150,000)
1
$ 90,000
1/(1+0.09)^1
0.91743119
$ 82,569
2
$ 52,500
1/(1+0.09)^2
0.84167999
$ 44,188
3
$ 45,000
1/(1+0.09)^3
0.77218348
$ 34,748
4
-
1/(1+0.09)^4
0.70842521
-
5
-
1/(1+0.09)^5
0.64993139
-
NPV
$ 11,505
Project: Tom
Year
Cash Flow
Formula for PV Factor
PV Factor @ 9%
PV
0
$ (150,000)
1/(1+0.09)^0
1
$ (150,000)
1
$ 45,000
1/(1+0.09)^1
0.91743119
$ 41,284
2
$ 45,000
1/(1+0.09)^2
0.84167999
$ 37,876
3
$ 45,000
1/(1+0.09)^3
0.77218348
$ 34,748
4
$ 45,000
1/(1+0.09)^4
0.70842521
$ 31,879
5
$ 45,000
1/(1+0.09)^5
0.64993139
$ 29,247
NPV
$ 25,034
Project: Ulma
Year
Cash Flow
Formula for PV Factor
PV Factor @ 9%
PV
0
$ (150,000)
1/(1+0.09)^0
1
$ (150,000)
1
-
1/(1+0.09)^1
0.917431
-
2
-
1/(1+0.09)^2
0.84168
-
3
$ 67,500
1/(1+0.09)^3
0.772183
$ 52,122
4
$ 97,500
1/(1+0.09)^4
0.708425
$ 69,071
5
$ 127,500
1/(1+0.09)^5
0.649931
$ 82,866
NPV
$ 54,060
Based on NPV results project Ulma should be selected.
c)
Ralph
Susie
Tom
Ulma
Year
Cash Flow
Cash Flow
Cash Flow
Cash Flow
0
$ (150,000)
$ (150,000)
$ (150,000)
$ (150,000)
1
$ 30,000
$ 90,000
$ 45,000
-
2
$ 37,500
$ 52,500
$ 45,000
-
3
$ 37,500
$ 45,000
$ 45,000
$ 67,500
4
$ 67,500
-
$ 45,000
$ 97,500
5
$ 82,500
-
$ 45,000
$ 127,500
IRR
17.02%
13.87%
15.24%
37.37%
As per IRR project Ulma is selected.
Year
Cash Flow
Cumulative cash flow
0
$ (150,000)
$ (150,000)
1
$ 30,000
$ (120,000)
2
$ 37,500
$ (82,500)
3
$ 37,500
$ (45,000)
4
$ 67,500
$ 22,500
5
$ 82,500
$ 105,000
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