Consider the follow 17 Comparing Investment Criteria LO1 2 3

Consider the follow 17. Comparing Investment Criteria /LO1, 2 3 mutually exclusive projects: Year Cash Flow (A)ow (B $455,000 58,000 85,000 85,000 572,000 965,000 31,000 28,000 25,500 19,000 11 percent on you Whichever project you choose, if any, you require a return of I investment a. If you apply the payback criterion, which investment will yo b. If you apply the discounted payback criterion, which invest will you choose Why? e. If you ap d. If you apply the IRR criterion, which investment will you choose? Why? ply the NPV criterion, which investment will you choose? Why? e. If you apply the profitability index criterion, which investment will you choose Why? ased on your answers in (a) through (e), which project will you finally chood Why?

Solution

A.

Payback for A = 3+(227,000/572,000) = 3.40 years

Paybak for B = 2+(6,000/25,500) = 2.24 years

B will be selected as it has a shorter payback period.

b.

Discounted payback of A = 3+(271608.57/376794.12) = 3.72 years

Discounted payback of B = 2+(14346.64/18645.38* = 2.77 years

B will be slected as it has a shorter payback period.

c.

As NPV of A is higher A will be selected.

d. IRR is the rate which makes the NPV as nil. It will be computed using a trial and error method.

Thus IRR of A = 18.15 %

Thus IRR of B = 23.65%

B will be selected as it has a higher IRR.

e. Profitability index (PI)= 1+(net present value/initial investment required)

PI for A = 1+(105185.54/455000) = 1.23

PI for B = 1+(16814.62/65000) = 1.26

B will be selected as it has a higher Profitability Index.

f. I will finally select B as it has a higher IRR than A. Besides B also has higher NPV and higher PI as well.

Year	Cash flow (A)	Cumulative cash flow (A)	Cash flow (B)	Cumulative cash flow (B)
0	-455,000.00	-455,000.00	-65,000.00	-65,000.00
1	58,000.00	-397,000.00	31,000.00	-34,000.00
2	85,000.00	-312,000.00	28,000.00	-6,000.00
3	85,000.00	-227,000.00	25,500.00	19,500.00
4	572,000.00	345,000.00	19,000.00