Question

Novell, Inc., has the following mutually exclusive projects.

  

Year		Project A		Project B
0		–$28,000		–$31,000
1		16,000		17,000
2		12,500		11,000
3		3,700		12,500

  

a-1.	Calculate the payback period for each project. (Do not round intermediate calculations and round your answers to 3 decimal places, e.g., 32.161.)

      

a-2.	If the company's payback period is two years, which, if either, of these projects should be chosen?
	Project A Project B Both projects Neither project

  

b-1.	What is the NPV for each project if the appropriate discount rate is 15 percent? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

      

b-2.	Which, if either, of these projects should be chosen if the appropriate discount rate is 15 percent?
	Project A Project B Both projects Neither project

Answer 1

(a-1)

Let us find the cumulative cash flows for each project -

Year	Project A	Cumulative A	Project B	Cumulative B
0	-28000	-28000.00	-31000.00	-31000.00
1	16000	-12000.00	17000.00	-14000.00
2	12500	500.00	11000.00	-3000.00
3	3700	4200.00	12500.00	9500.00

Since the cumulative cash flow becomes +ve after Year 1, Payback for Project A = 1 + 12000/12500 =  1.96 years

For Project B, Payback period = 2 + 3000/12500 = 2.24 years

(a-2) Project A should be accepted since payback period of Project A is less than 2 years

(b-1)

Discount rate = r = 15%

NPV = -CF0 + CF1/(1+r) + CF2/(1+r)² + CF3/(1+r)³

NPV for Project A = -28000 + 16000/1.15 + 12500/1.15² + 3700/1.15³ = $ -2202.35

NPV for Project B = -31000 + 17000/1.15 + 11000/1.15² + 12500/1.15³ = $ 319.14

(b-2) Since Project B has NPV >0, it should be accepted