Pound Industries is attempting to select the best of three mutually exclusive pr

Question

Pound Industries is attempting to select the best of three mutually exclusive projects. The initial investment and after-tax cash inflows associated with these projects are shown in the following table. Calculate the payback period for each project. Calculate the net present value (NPV) of each project, assuming that the firm has a cost of capital equal to 8%. Calculate the internal rate of return (IRR) for each project. Indicate which project you would recommend. The payback period of project A is years. The payback period of project B is years

Explanation / Answer

a.

Payback period = Initial investment/ Annual cash inflows

Payback period of Project A = $130,000/$40,000 = 3.25

Payback period of Project B = $160,000/$52,000 = 3.08

Payback period of Project C = $160,000/$53,000 = 3.02

b.

Present value annuity factor at 8% for 5 years = {1 – (1+r)-n}/r = (1 – 1.08-5)/0.08 = 3.9927

Project

A

B

C

1

Initial investment

$ 130,000.00

$ 160,000.00

$ 160,000.00

2

Cash inflow

$ 40,000.00

$ 52,000.00

$ 53,000.00

3

Present value annuity factor

3.9927

3.9927

3.9927

4

Present value of annual cash inflow (2*3)

$ 159,708.00

$ 207,620.40

$ 211,613.10

5

Net present value (1-4)

$ 29,708.00

$ 47,620.40

$ 51,613.10

d.

Project C having highest NPV is recommended as all three projects have almost equal payback period with marginal difference.

Project

A

B

C

1

Initial investment

$ 130,000.00

$ 160,000.00

$ 160,000.00

2

Cash inflow

$ 40,000.00

$ 52,000.00

$ 53,000.00

3

Present value annuity factor

3.9927

3.9927

3.9927

4

Present value of annual cash inflow (2*3)

$ 159,708.00

$ 207,620.40

$ 211,613.10

5

Net present value (1-4)

$ 29,708.00

$ 47,620.40

$ 51,613.10

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