Question

Senior management asks you to recommend a decision on which project(s) to accept based on the cash flow forecasts provided.

Relevant information:

1. The firm uses a 3-year cutoff when using the payback method.
2. The hurdle rate used to evaluate capital budgeting projects is 15%.

The cash flows for projects A, B and C are provided below.

	Project A	Project B	Project C
Year 0	-30,000	-20,000	-50,000
Year 1	0	4,000	20,000
Year 2	7,000	5,000	20,000
Year 3	20,000	6,000	20,000
Year 4	20,000	7,000	5,000
Year 5	10,000	8,000	5,000
Year 6	5,000	9,000	5,000

1. Assume the projects are independent and answer the following:
   • Calculate the payback period for each project.
   • Which project(s) would you accept based on the payback criterion?
   • Calculate the internal rate of return (IRR) for each project.
   • Which projects would you accept based on the IRR criterion?
   • Calculate the net present value (NPV) for each project.
   • Which projects would you accept based on the NPV criterion?
     
2. Assume the projects are mutually exclusive and answer the following:
   • Which project(s) would you accept based on the payback criterion?
   • Which projects would you accept based on the IRR criterion?
   • Which projects would you accept based on the NPV criterion?

Submission Instructions:

• Complete and submit the assignment by 23:59 Sunday.
• You should submit your completed work in a Word document or Excel spreadsheet if needed.

Grading Rubric

Answer 1

The payback period is the number of years it takes for the project to break even, i.e the number of years it takes for the sum of the cashflow to be higher than the initial investment

For Project A, this occurs after the 3rd year ( -30,000 + 0 + 7,000 + 20,000 + 20,000 > 0 )

For Project B, this occurs after the 3rd year ( -20,000 + 4,000 + 5,000 + 6,000 + 7,000 > 0 )

For Project C, this occurs after the 2nd year ( -50,000 + 20,000 + 20,000 + 20,000 > 0 )

Based on payback period, Project C should be selected

Projects with IRR greater than the required rate of return (hurdle rate) should be accepted.

Projects with positive NPV should be selected.

Based on IRR, Project A should be selected.

Based on NPV, Project A should be selected.