You are considering the following two mutually exclusive projects. Both projects

Question

You are considering the following two mutually exclusive projects. Both projects will be depreciated using straight-line depreciation to a zero book value over the life of the project. Neither project has any salvage value.

Project A               Project B

a. (5 points) What is the NPV for each of the projects? Which project should be accepted if NPV method is applied? Explain why.

b. (5 points) What is the IRR for each of the projects? Which project should be accepted if IRR method is applied? Explain why.

c. (5 points) What is the payback period for each of the projects? Which project should be accepted if payback period method is applied? Explain why.

d. (5 points) What is the discounted payback period for each of the projects? Which project should be accepted if discounted payback period method is applied? Explain why.

e. (5 points) What is the profitability index for each of the projects? Which project should be accepted if profitability index method is applied? Explain why.

f. (5 points) What is the average accounting return (AAR) for each of the projects, assuming that cash flows occurring after year 0 are net income? Which project should be accepted if AAR method is applied? Also, assume that the target AAR is 10%.

g. (5 points) Define and find the crossover rate.

h. (5 points) Sketch the NPV profile. Plot all the relevant coordinates (i.e., the points on the x and y axis; and the cross-over rate) on the graph.

Project A Project B Year Cash Flow Year Cash Flow 0 -$45,000 0 -$40,000 1 $17,500 1 $8,200 2 $18,000 2 $14,600 3 $22,500 3 $36,800

Explanation / Answer

NPV Mthod

=-45000 + 17500/(1.08) + 18000/(1.08)
^2 + 22500/(1.08)^3

=4163.91

NPV method

=-40000 + 8200/1.12+ 14600/1.12^2 +36800/(1.12)^3

=4601.76

Hence Project B would be accepetd

2.

IRR using financial calculator

Project A = 13%

Project B = 18%

Hence project with higher irr is selected

c) Payback period for project A = 2.42

years

Payback period for project B =2.46

Hence here project A would be accepetd

d) Profitability Index A

= NPV of cashflows to be recoeved /Initial Investment

=49,497/45000 =1.1

Profitability Index B

=45,153/40000

=1.13

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