Company K is considering two mutually exclusive projects. The cash flows of the

Question

Company K is considering two mutually exclusive projects. The cash flows of the project are:

Year Project A Project B
Initial Outlay -$1,700,000 -$1,700,000
1 400,000
2 400,000
3 400,000
4 400,000
5 400,000
6 400,000
7 400,000 $4,250,000

a. Compute the payback period for each project.
b. Compute the NPV for each project, assuming a 13% required rate of return.
c. Compute the Profitability Index for each Project.
d. Fully explain your logic, how would you decide between these two projects and which would you recommend?

Show calculations for a-c.

Explanation / Answer

a. payback period Project A = 4+($1,700,000-$400,000*4)/$400,000 =4.25 years payback period Project B = 6+ $1,700,000/$4,250,000 =6.4 years b.NPV for Project A = -$1,700,000+ $400,000/1.13 + $400,000/1.13^2 ...$400,000/1.13^7 = $69,044.17 NPV for Project B = -$1,700,000 +$4,250,000/1.13^7 = $106,507.7359 c. Profitability Index for Project A = NPV/Initial Outlay=$69,044.17/$1,700,000 =4.06% Profitability Index for Project B = NPV/Initial Outlay=$106,507.7359/$1,700,000 =6.27% d. I would recommend Project B as it has higher NPV and Profitability Index than Project A.

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