Consider the following cash flows of two mutually exclusive projects for AZ-Moto

Question

Consider the following cash flows of two mutually exclusive projects for AZ-Motorcars. Assume the discount rate for AZ-Motorcars is 10 percent.

What is the payback period for each project? (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))

   

      

  

   

   

2.

Consider two streams of cash flows, A and B. Stream A

a.

What is the payback period for each project? (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))

Explanation / Answer

Since, the question posted has multiple questions having multiple sub-parts, the first question relating to AZ motors has been answered in full.

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Part A)

Payback period is the period within which the initial investment is expected to be recovered with the use of annual cash inflows.

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We need to calculate the cumulative cash flows in order to determine the payback period,

AZM Mini-SUV:

Since, the cumulative cash flows turn positive in the year 2, it indicates that the total investment of $300,000 gets recovered between year 1 and 2. The formula for calculating payback period is:

Payback Period = Year upto which partial recovery is made + Balance/Cash flow of the year in which full recovery is made

Payback Period = 1 + (300,000 - 270,000)/180,000 = 1.17 Years

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AZF Full-SUV:

Since, the cumulative cash flows turn positive in the year 2, it indicates that the total investment of $600,000 gets recovered between year 1 and 2. The formula for calculating payback period is:

Payback Period = Year upto which partial recovery is made + Balance/Cash flow of the year in which full recovery is made

Payback Period = 1 + (600,000 - 250,000)/400,000 = 1.88 years

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Part B)

NPV is the difference between present value of cash inflows and present value of cash outflows. Present value is calculated with the use of discount rate. The formula for calculating NPV is:

NPV = Cash Flow Year 0 + Cash Flow Year 1/(1+Discount Rate)^1 + Cash Flow Year 2/(1+Discount Rate)^2 + Cash Flow Year 3/(1+Discount Rate)^3

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AZF Mini-SUV:

NPV = -300,000 + 270,000/(1+.10)^1 + 180,000/(1+.10)^2 + 150,000/(1+.10)^3 = $206.912.10

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AZF Full-SUV:

NPV = -600,000 + 250,000/(1+.10)^2 + 400,000/(1+.10)^2 + 300,000/(1+.10)^3 = $183.245.68

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Part C)

IRR is the minimum rate of return below which a project will not be accepted. IRR can be calculated with the use of IRR function in EXCEL/Financial Calculator. The general formula for calculating IRR is:

NPV = 0 = Cash Flow Year 0 + Cash Flow Year 1/(1+IRR)^1 + Cash Flow Year 2/(1+IRR)^2 + Cash Flow Year 3/(1+IRR)^3

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AZF Mini-SUV:

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AZF Full-SUV:

Year Cash Inflow Cumulative Cash Inflow 0 -300,000 0 1 270,000 -30,000 2 180,000 150,000 3 150,000 300,000

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