Question

Question 1.

Bigg company is evaluating two projects for next year’s capital budget. The after-tax cash flows (including depreciation) for each project are the following:

	Project A	Project B
Year 0	-6,000	-18,000
Year 1	2,000	5,600
Year 2	2,000	5,600
Year 3	2,000	5,600
Year 4	2,000	5,600
Year 5	2,000	5,600
Year 6	4,000	9,000

a.) If the company’s WACC is 14%, find the NPV, IRR, payback, and discount payback for each project.

b.) If the projects are mutually exclusive, what is your recommendation to the company?

Answer 1

Project A :

CF0 = ($6,000)

CF1= $2000

CF2= $2000

CF3= $2000

CF4 = $2000

CF5= $2000

CF6= $4000

At the required rate of return of 14%, the NPV is = $2688.51, IRR = 27.81%

Payback period = 3 years ( $6000 investment is recovered in 3 years)

Year1 : $1754.38

year 2 : $1538.93

year 3 = $1349.94

year 4 = $1184.16

year 5 = $1038.73

Discounted payback is :

4 + $172.5/$10388.73

=4.166 years

Project B :

CF0 = (18,000)

CF1= $5,000

CF2= $5000

CF3= $5000

CF4= $5000

CF5= $5000

CF6= $9000

The NPV is = $3,265.68

IRR =19.93%

Payback period : 3 + 3,000/5,000

= 3.6 year

Discounted pay back is : 4.3 years

Year 1 : $4912.28

year 2 : $4309.0182

year 3 : $3779.84

year 4 : $3315.6496

year 5 : $2908.46

discounted pay back = 4 + $1683.21/5600

=4.3 years

On the basis of NPV, we will select the project which has the highest NPV, so we should select project B.