8.3. Which Project should be accepted A or B? a. The payback for Project A is: P

Question

8.3. Which Project should be accepted A or B?

       a. The payback for Project A is: Payback =

       b. The payback for Project B is: Payback =

       c. Which project should be accepted:

8.4. Calculating AAR, the average net income divided by the average book value. (Show work by calculating net income and average book value):

       a. Average net income =

       b. Average book value =

       c. AAR =

8.5. Calculating IRR the interest rate that makes the NPV of the project equal to zero. (Show work by calculating IRR):

       a. IRR =

       b. Should the project be accepted and why?

8.6. Calculating NPV. Hint the NPV of a project is the PV of the outflows minus by the PV of the inflows. (Show work by calculating NPV):

       a. @ 9% required return.

            NPV@ 9% required return =

       b. Should the project be accepted:

       c. @ 21% required return.

            NPV@ 21% required return =

                        d. Should the project be accepted:

Explanation / Answer

1.

.Payback period is a capital budgeting technique, it calculates in how much year’s initial investment in the project would be recovered from the cash flows generated by the Investment. It is expressed in years. Pay back is calculated by dividing Initial investment by cash inflow generated by the investment, when cash inflows are even. When Cash inflows are uneven then we have to cumulative the cash flows till it equals to 0 or negative in year that it becomes zero or negative that year or proportionate year will be the payback period. The project with an investment with shorter period would be selected, since the investor’s investment is at risk for shorter period of life. The payback period should not be used as a sole criterion for capital investment decision making, it should always be used with NPV and IRR to incorporate time value of money concept.

2. The main disadvantage of payback method is it does not consider time value of money concept. Secondly if life span of machine expires after payback period, it will not consider additional income generated. The payback concentrates on the periods it will recoup the initial investment and ignored the profitability of the project.

3. The advantage of payback its help in analysis of risk associated with return of initial investment. The projects with shorter time period are selected and longer periods ignored by the payback. It’s suitable for companies where investment obsolete quickly and initial investment recovery is a problem

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