Diaz Camera Company is considering two investments, both of which cost $10,000.

Question

Diaz Camera Company is considering two investments, both of which cost $10,000. The cash flows are as follows: Year1, Project A $6,000, Project B $5,000 - Year 2, Project A $4,000, Project B $3,000 Year 3, Project A, $3,000, Project B $8,000.
a. Which of the two projects should be chosen based on payback method(show work)?
b. Which of the two projects should be chosen based on the net present value method(show work)? Assume a cost of capital of 10 percent.
C. Should a firm normally have more confidence in answer a or answer b?

Explanation / Answer

payback period for A = 1+1 = 2 yrs pay back period for B = 1+1+2000/8000 = 2.25 yrs as payback period for project A is less than B , project B is choosen b) NPV for project A = -10000 + 6000/(1.1) +4000/(1.1)^2 + 3000/(1.1)^3 =$3000 NPV for B = -10000 + 5000/(1.1) +3000/(1.1)^2 + 8000/(1.1)^3 =$6,000 so based on NPV , project B is choosen c)firm normally have more confidence in b , that is NPV as it considers time value mof money

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