A company is considering two projects which provides the following cash flows: T

Question

A company is considering two projects which provides the following cash flows: The company's cost of capital is 9% The initial investment Would be $60,000 The company mineral criteria for project acceptance are: Payback of 4 years or less NPV - based on cost of capital plus 5% Which project(s) would be accepted under payback'.' Which project(s) would be accepted under NPV? Company XYZ it considering; n investment in a project I he financials associated with this project for year are: Sales & Epic uses are expected to increase by [2% Fixed Asset (Investment) asset Sled with this project are expected to coil Fixed Assets will be depreciated via the 5 year MACRS The pro eel will be evaluated over 3 years. The Company is in the 40degree. Tax bracket What is the maximum acceptable hurdle rate for hit product to be approved via NPV? Provide proof what is the payback '

Explanation / Answer

Part A)

To compute payback period, we first need to prepare a cumulative cash flow table:

Project A

Year

Cash flow

Cumulative CF

0

-60000

-60000

1

27000

-33000

2

14000

-19000

3

16000

-3000

4

30000

27000

Payback period = Last year of negative CCF + last negative CCF / CF in in first positive CCF year

                                = 3 + 3000/30000

                                = 3.10 years

Project B

Year

Cash flow

Cumulative CF

0

-60000

-60000

1

0

-60000

2

0

-60000

3

55000

-5000

4

35000

30000

Payback period = Last year of negative CCF + last negative CCF / CF in in first positive CCF year

                                = 3 + 5,000/35000

                                = 3.14 years

Since both the projects have payback period below 4 years, both the projects should be selected.

Part A)

NPV is the sum of present value of cash flows. Present values are calculated by multiplying cash flows with the PV factors.

Year

CF A

CF B

PV factor 14%

PV A

PV B

0

-60000

-60000

1.00000

-60000

-60000

1

27000

0

0.87719

23684.21

0

2

14000

0

0.76947

10772.55

0

3

16000

55000

0.67497

10799.54

37123.43

4

30000

35000

0.59208

17762.41

20722.81

NPV

3018.71

-2153.76

Only project A would be selected as it has the positive NPV.

Year

Cash flow

Cumulative CF

0

-60000

-60000

1

27000

-33000

2

14000

-19000

3

16000

-3000

4

30000

27000

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