Suppose your firm is considering two mutually exclusive, required projects with

Question

Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown below. The required rate of return on projects of both of their risk class is 12 percent, and that the maximum allowable payback and discounted payback statistic for the projects are 2 and 3 years, respectively. Time: 0 1 2 3 Project A Cash Flow -34,000 24,000 44,000 15,000 Project B Cash Flow -44,000 24,000 34,000 64,000 Use the NPV decision rule to evaluate these projects; which one(s) should it be accepted or rejected?

Explanation / Answer

Project A Year 0 Year 1 Year 2 Year 3 Cash Flow         (34,000)        24,000        44,000       15,000 Discount Factor @12%                      1        0.8929        0.7972       0.7118 PV of Cash Flows         (34,000)        21,429        35,077       10,677 NPV           33,182 Payback period years                1.22 Discounted Payback period years                1.36 Project B Year 0 Year 1 Year 2 Year 3 Cash Flow         (44,000)        24,000        34,000       64,000 Discount Factor @12%                      1        0.8929        0.7972       0.7118 PV of Cash Flows         (44,000)        21,429        27,105       45,554 NPV           50,087 Payback period years                1.59 Discounted Payback period years                1.83 Based on Payback And discounted payback both the projects are acceptable Based on NPV , Project B shall be accepted due to higher NPV.

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