Nicholson roofing materials, inc., is considering two mutually exclusive project

Question

Nicholson roofing materials, inc., is considering two mutually exclusive projects., each with an initial investment of $150,000. The company's board of directors has set a maximum 4-year payback requirement and has set its cost of capital at 9%. The cash inflows associated with the two projects are shown in the following table

a. Calculate the payback period for each project.

b. Calculate the NPV of each project at 0%

c. Calculate the NPV of each project at 9%

d. Derive the IRR of each project.

e. Rank the projects by each of hte techniques used. Make and justify a recommendation.

F. Go back one more time and calculate the NPV of each prject using a cost of capital of 12%. Does the ranking of the two projects change compared ot your answer in part e? Why?

Please show work in Excel.

Year Project A Project B 1 45000 75000 2 45000 60000 3 45000 30000 4 45000 30000 5 45000 30000 6 45000 30000

Explanation / Answer

Project A :

In 3 years 45,000 * 3 = $ 135,000 is the total inflow.

So,the balance 150,000 - 135,000 = $ 15,000 will be recovered in the fourth year.

Now, we can see that 45,000 is earned in 12 months

Hence, to earn 15,000 time required : 12/45,000 * 15,000 = 4 months (Approx)

So, the payback period for Project A is 3 years and 4 months.

Project B :

In 2 years 75,000 + 60,000 = $ 135,000 is the Inflow.

So, the balance 150,000 - 135,000 = $ 15,000 was recovered in 3rd year.

The inflow for 3rd year was 30,000 which was in 12 months

So, for 15,000 they required 6 months

Hence, the payback period of Project B is 2 years and 6 months.

NPV at 0 % :

NPV of Project A : 270,000 - 150,000 = $ 120,000

NPV of Project B : 255,000 - 150,000 = $ 105,000

NPV when COC is 9 % : Project A

Inflow/(1 + 9/100)n

n = no of years

45,000/(1 + .09)1

45,000/(1 + .09)2

45,000/(1 + .09)3

45,000/(1 + .09)4

45,000/(1 + .09)5

45,000/(1 + .09)6

Hence NPV of Project B at 9 % COC is 204,240 - 150,000 = $ 54,240

Project B :

75,000/(1 + .09)1

60,000/(1 + .09)2

30,000/(1 + .09)3

30,000/(1 + .09)4

30,000/(1 + .09)5

30,000/(1 + .09)6

So, NPV of Project B is 201,114 - 150,000 = $ 51,114

IRR for Project A :

-150,000 + 45,000/(1 + 9/100)1 + 45,000/(1 + 9/100)2 + 45,000/(1 + 9/100)3 + 45,000/(1 + 9/100)4 + 45,000/(1 + 9/100)5 + 45,000/(1 + 9/100)6

Putting the values in IRR calculator we get 19.91 %

IRR for Project B :

-150,000 + 75,000/(1 + 9/100)1 + 60,000/(1 + 9/100)2 + 30,000/(1 + 9/100)3 + 30,000/(1 + 9/100)4 + 30,000/(1 + 9/100)5 + 30,000/(1 + 9/100)6

Putting the values in IRR calculator we get 22.72 %

Project B is more profitable as it be seen from the calculations.IRR of Project B is much higher as compared to Project A.Also, the payback period of Project B is lower so it must be given the priority.

NPV at COC 12 % : Project A

Inflow/(1 + 12/100)n

45,000/(1 + .12)1

45,000/(1 + .12)2

45,000/(1 + .12)3

45,000/(1 + .12)4

45,000/(1 + .12)6

Hence NPV will be 185,006 - 150,000 = 35,006

NPV at COC 12 % : Project B

75,000/(1 + .12)1

60,000/(1 + .12)2

30,000/(1 + .12)3

30,000/(1 + .12)4

30,000/(1 + .12)5

30,000/(1 + .12)6

So, NPV for Project B will be 187,432 - 150,000 = $ 37,432

The management should give the priorith to Project B.The payback period i.e. BEP is less also IRR is higher to Project A.NPV is also considerably good.

Year Project A ($) Project B ($) I 45,000 75,000 II 45,000 60,000 III 45,000 30,000 IV 45,000 30,000 V 45,000 30,000 VI 45,000 30,000 Total 270,000 255,000

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