8. Valley Products, Inc. is considering two independent investments having the f

Question

8. Valley Products, Inc. is considering two independent investments having the following cash flow streams: Year Project A Project B 0 -50,000 -40,000 1 20,000 20,000 2 20,000 10,000 3 10,000 5,000 4 5,000 ,5000 5 5,000 40,000 Valley uses a combination of the net present value approach and the payback approach to evaluate investment alternatives. It requires that all projects have a positive net present value when cash flows are discounted at 10 percent and that all projects have a payback no longer than three years. Which project or projects should the firm accept? Why?

Explanation / Answer

Reject both.

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Payback period: Project A = 3 years; Project B = 3.152 years

Project B is unacceptable because its payback period is too long.

Net present value:

NPVA = -$50,000 + $20,000 (0.909) + $20,000 (0.826) + $10,000 (0.751)

+ $5,000 (0.683) + $5,000 (0.621) = -$1,270

Project A is unacceptable because it fails to meet the NPV requirement. Therefore, neither project

should be undertaken by the company.

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