Consider the following cash flows of two mutually exclusive projects for Spartan

Question

Consider the following cash flows of two mutually exclusive projects for Spartan Rubber Company. Assume the discount rate for Spartan Rubber Company is 10 percent.

a. Based on the payback period, which project should be taken?

b. Based on the NPV, which project should be taken?

c. Based on the IRR, which project should be taken?

d. Based on the above analysis, is incremental IRR analysis necessary? If yes, please conduct the analysis.

Year Dry Prepreg Solvent Prepeg 0 -1,600,000 -850,000 1 640,000 530,000 2 490,000 380,000 3 1,100,000 320,000

Explanation / Answer

a. Pay Back Perid Method

Dry Prepreg

Cost of Project 1,600,000, it takes 2 year and 5 month to Recovered this amount.

Time Required = 1,600,000 - 1,130,000 X 12
2,230,000 - 1,130,000

= 470,000    X 12
   1,100,000

= 5.12 takens as 5 month

Solvent Prepeg

Cost of Project 850,000, it takes 1 year and 2 month Recovered this amount.

Time Required = 910,000 - 850,000    X 12
910,000 - 530,000

= 60,000    X 12
380,000

= 1.89 taken as 2 month

Based on the Pay Back Period Solvent Prepeg Should be taken.

b. Based on the NPV

Dry Prepreg

Solvent Prepeg

Based on the NPV Dry Prepreg is Preferable as it has a Higher Net Present Value.

c.IRR

Present Value Factor = Initial Investment    
   Average Cash Inflow

Dry Prepreg

Average Cash Inflow = 640,000 + 490,000 + 1,100,000   
   3 Years

= 2,230,000
   3

   = 743,333

Initial Investment = Cost of Project 1600000

= 1600000
   743333

= 2.152

The P.V. factor is to be located in the P.V. Annuity Table is the Column of 3 Years 22% (2.042) Nearest 2.152.

So IRR = 22%

Solvent Prepeg

Average Cash Inflow = 530,000 + 380000 + 320,000   
   3 Years

= 1,230,000  
3

= 410,000

Initial Investment = Cost of Project 850,000

= 850,000
410,000

= 2.073

The Present Value Factor is to be located in the P.V. Annuity Table in the Column of 3 Years 22% (2.042) Nearest to 2.073.

So IRR = 22%

Based on the IRR Both Dry Prepreg and Solvent Prepeg is Same 22%

d. Based on the above analysis is Increment IRR Analysis Necessary

Trial And Error method is Used.

Analysis based on the Present Value Factor 10%, 12%, 14% and 15%.

Year Cash Inflow Cumulative Cash Inflow 1 640,000 640,000 2 490,000 1,130,000 3 1,100,000 2,230,000

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.