Question

1. Calculating Payback Period and NPV - Fuji software, Inc., has the following mutually exclusive projects

Year	Project A	Project B
0	-$15,000	-$18,000
1	9,500	10,500
2	6,000	7,000
3	2,400	6,000

a. Suppose Fuji’s payback period cutoff is two years. Which of these two projects should be chosen?

b. Suppose Fuji uses the NPV rule to rank these two projects. Which project should be chosen if the appropriate discount rate is 15 percent?

Answer 1

a)

Project A:

Cumulative cash flow for year 0 = -15,000

Cumulative cash flow for year 1 = -15,000 + 9,500 = -5,500

Cumulative cash flow for year 2 = -5,500 + 6,000 = 500

5,500 / 6,000 = 0.92

Payback period of project A = 1 + 0.92 = 1.92 years

Project B:

Cumulative cash flow for year 0 = -18,000

Cumulative cash flow for year 1 = -18,000 + 10,500 = -7,500

Cumulative cash flow for year 2 = -7,500 + 7,000 = -500

Cumulative cash flow for year 3 = -500 + 6,000 = 5,500

500 / 6,000 = 0.08

Payback period of project B = 2 + 0.08 = 1.08 years

Fuji should choose project A as it has a payback within 2 years.

2)

Project A:

NPV = Present value of cash inflows - present value of cash outflows

NPV of project A = -15,000 + 9500 / (1 + 0.15)¹ + 6000 / (1 + 0.15)² + 2400 / (1 + 0.15)³

NPV of project A = -624.23

Project B:

NPV = Present value of cash inflows - present value of cash outflows

NPV of project B = -18,000 + 10,500 / (1 + 0.15)¹ + 7000 / (1 + 0.15)² + 6000 / (1 + 0.15)³

NPV of project B = 368.54

Fuji should choose project B as it has the highest NPV.