Company K is considering two mutually exclusive projects. The cash flows outlay

Question

Company K is considering two mutually exclusive projects. The cash flows outlay and incomes of the projects are:

Year Project A Project B

Initial Outlay -$2,000,000 -$2,000,000

1 400,000

2 400,000

3 400,000

4 400,000

5 400,000

6 400,000

7 400,000 4,250,000

a. Compute the payback period for each project.

b. Compute the NPV for each project, assuming a 13% required rate of return.

c. Compute the Profitability Index for each project, assuming a 13% required rate of return.

d. Fully explaining your logic, assuming you ARE going to invest in one of these two projects, how would you decide between the two projects?

Explanation / Answer

Project A Year Cumulative Discount Net Flow 0 -2000000 -2000000 1 -2000000 1 400000 -1600000 0.884956 353982.3 2 400000 -1200000 0.783147 313258.7 3 400000 -800000 0.69305 277220.1 4 400000 -400000 0.613319 245327.5 5 400000 0 0.54276 217104 6 400000 400000 0.480319 192127.4 7 400000 800000 0.425061 170024.3 NPV -230956 = Payback Period = 5 years Project B Year Cumulative Discount Net Flow 0 -2000000 -2000000 1 -2000000 1 -2000000 0.884956 0 2 -2000000 0.783147 0 3 -2000000 0.69305 0 4 -2000000 0.613319 0 5 -2000000 0.54276 0 6 -2000000 0.480319 0 7 4250000 2250000 0.425061 1806508 NPV -193492 = Payback Period = 6.5 Years approximately

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