Question

PAYBACK PERIOD

Project L costs $70,000, its expected cash inflows are $15,000 per year for 11 years, and its WACC is 10%. What is the project's payback? Round your answer to two decimal places.

b)

CAPITAL BUDGETING CRITERIA: MUTUALLY EXCLUSIVE PROJECTS

A firm with a WACC of 10% is considering the following mutually exclusive projects:

0

1

2

3

4

5

Project 1	-$350	$75	$75	$75	$225	$225
Project 2	-$500	$200	$200	$50	$50	$50

Which project would you recommend?

Select the correct answer.

a. Project 2, since the NPV2 > NPV1.

b. Neither Project 1 nor 2, since each project's NPV < 0.

c. Both Projects 1 and 2, since both projects have IRR's > 0.

d. Project 1, since the NPV1 > NPV2.

e. Both Projects 1 and 2, since both projects have NPV's > 0.

Answer 1

a.Payback period=Initial investment/Annual cash flows

=(70000/15000)

=4.67 years(Approx)

b.

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

Project 1:

Present value of inflows=75/1.1+75/1.1^2+75/1.1^3+225/1.1^4+225/1.1^5

=$479.90

NPV=Present value of inflows-Present value of outflows

=$479.90-$350

=$129.90

Project 2:

Present value of inflows=200/1.1+200/1.1^2+50/1.1^3+50/1.1^4+50/1.1^5

=$449.87

NPV=Present value of inflows-Present value of outflows

=$449.87-$500

=($50.13)(Approx)(Negative).

Hence Project 1 must be chosen having higher and positive NPV.(option D).