Question

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

  

Year		Project A		Project B
0		–$27,000		–$30,000
1		15,500		16,500
2		12,000		10,500
3		3,600		12,000

  

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 14 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 14 percent?
	Project A Project B Both projects Neither project

Answer 1

a)

Project A:

Cumulative cash flow for year 0 = -27000

Cumulative cash flow for year 1 = -27000 + 15500 = -11,500

Cumulative cash flow for year 2 = -11,500 + 12000 = 500

11,500 / 12000 = 0.958

Payback period of project A = 1 + 0.958 = 1.958 years

Project B:

Cumulative cash flow for year 0 = -30000

Cumulative cash flow for year 1 = -30000 + 16500 = -13,500

Cumulative cash flow for year 2 = -13,500 + 10500 = -3,000

Cumulative cash flow for year 3 = -3,000 + 12000 = -9,000

3,000 / 12000 = 0.25

Payback period of project B = 2 + 0.25 = 2.250 years

Company should choose project A as it has a payback period less than 2

b)

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

Project A:

NPV = -27,000 + 15,500 / (1+0.14)¹ + 12,000 / (1+0.14)² + 3,600 / (1+0.14)³

NPV = -$1,740.00

Project B:

NPV = -30,000 + 16,500 / (1+0.14)¹ + 10,500 / (1+0.14)² + 12,000 / (1+0.14)³

NPV = $652.75

Project B should be chosen as it has the positive NPV