Galaxy Inc. is considering Projects S and L, whose cash flows are shown below. T

Question

Galaxy Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the shorter payback, some value may be forgone. How much value will be lost in this instance? Note that under some conditions choosing projects on the basis of the shorter payback will not cause value to be lost. WACC. 8.00% CFS Year CFL $950 $500 800 $2,100 $400 $800 $800 $1,000 ) $203.58 $188.40 $95.03 $173 37

Explanation / Answer

Payback of S=1+450/800=1.5625

Payback of L=2+900/1000=2.9

So, as per payback we will choose S

NPV of S=-950+500/1.08+800/1.08^2=198.834

NPV of L=-2100-400/1.08+800/1.08^2+800/1.08^3+1000/1.08^4=-414.404

In this case S is the better project hence value is not lost by choosing the project with the shorter payabck period

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