Here are the expected cash flows for three projects: Cash Flows (dollars) Projec
ID: 2731958 • Letter: H
Question
Here are the expected cash flows for three projects: Cash Flows (dollars) Project Year: 0 1 2 3 4 A 6,500 + 1,375 + 1,375 + 3,750 0 B 2,500 0 + 2,500 + 2,750 + 3,750 C 6,500 + 1,375 + 1,375 + 3,750 + 5,750
a. What is the payback period on each of the projects? Project Payback period A years B years C years
b. If you use a cutoff period of 2 years, which projects would you accept? Project A Project B Project C Project A and Project B Project B and Project C Project A and Project C Projects A, B, and C None
c. If you use a cutoff period of 3 years, which projects would you accept? Project A Project B Project C Project A and Project B Project B and Project C Project A and Project C Projects A, B, and C None
d-1. If the opportunity cost of capital is 12%, calculate the NPV for projects A, B, and C. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to 2 decimal places.) Project NPV A $ B $ C $
d-2. Which projects have positive NPVs? Project A Project B Project C Project A and Project B Project B and Project C Project A and Project C Projects A, B, and C None
e. "Payback gives too much weight to cash flows that occur after the cutoff date." True or false? True False
Explanation / Answer
Part A
To compute payback period, we first need to prepare cumulative cash flow table.
Project A
Year
Cash flow
CCF
0
-6500
-6500
1
1375
-5125
2
1375
-3750
3
3750
0
4
0
0
PBP = Last year of negative CCF + last negative CCF / CF in First year of positive CCF
= 2 + 3750 /3750
= 3 years
Project B
Year
Cash flow
CCF
0
-2500
-2500
1
0
-2500
2
2500
0
3
2750
2750
4
3750
6500
PBP = Last year of negative CCF + last negative CCF / CF in First year of positive CCF
= 1 + 2500 /2500
= 2 years
Project C
Year
Cash flow
CCF
0
-6500
-6500
1
1375
-5125
2
1375
-3750
3
3750
0
4
5750
5750
PBP = Last year of negative CCF + last negative CCF / CF in First year of positive CCF
= 2 + 3750 /3750
= 3 years
Part b
Only project B should be selected as it is the only project having 2 years of payback period.
Part C
All the projects should be selected as all the projects have payback period less than or equal to 3.
Part D
To compute NPV, we need to first multiply the cash flows with PV factor and get the PVs, thereafter we will add those PVs to get NPV.
Year
CF A
CF B
CF C
PV factor 12%
PV A
PV B
PV C
0
-6500
-2500
-6500
1
-6500.00
-2500.00
-6500.00
1
1375
0
1375
0.892857143
1227.68
0.00
1227.68
2
1375
2500
1375
0.797193878
1096.14
1992.98
1096.14
3
3750
2750
3750
0.711780248
2669.18
1957.40
2669.18
4
0
3750
5750
0.635518078
0.00
2383.19
3654.23
NPV
-1507.00
3833.57
2147.23
Therefore, NPV of project A is -1507.00, NPV of project B is 3833.57 and NPV of project C is 2147.23.
Year
Cash flow
CCF
0
-6500
-6500
1
1375
-5125
2
1375
-3750
3
3750
0
4
0
0
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