Payback Period Analysis for Mutually Exclusive Projects - Example 3 Question: Consider 2 mutually exclusive investments...

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Payback Period Analysis for Mutually Exclusive Projects - Example 3 Question: Consider 2 mutually exclusive investments with the following after tax cash flow (ATCF). Which project is economically better assuming a minimum rate of return of i* = 15% Note: in thousands j* = Project A B Solution for Project A YEAR ATCF Cummulative ATCF Solution for Project B YEAR ATCF 15% Year O -$200 -$200 Payback period = 4 + 200/600 = 4.33 years NPVA = $98.31 Cummulative ATCF Year O -200 -200 Year O -200 -200 Payback period = 2 + 40/80 = 2.5 years NPVB = $68.17 Year 1 $80 Year 1 0 -200 at i* = 15% Year 1 80 -120 Year 2 - $80 Year 2 0 -200 Year 2 80 -40 Year 3 1 $80 Year 3 0 -200 Year 3 80 40 Year 4 $80 Year 4 0 -200 Year 4 80 120 Year 5 $600 $80 Year 5 600 400 Year 5 80 200 at i* = 15% Answer: Although Project B has a lower payback period (2.5 years). However, Project A with a payback period of 4.33 years is more attractive for investment as it has a better NPV. 7 Payback Period Analysis for Mutually Exclusive Projects - Example 3 Question: Consider 2 mutually exclusive investments with the following after tax cash flow (ATCF). Which project is economically better assuming a minimum rate of return of i* = 15% Note: in thousands j* = Project A B Solution for Project A YEAR ATCF Cummulative ATCF Solution for Project B YEAR ATCF 15% Year O -$200 -$200 Payback period = 4 + 200/600 = 4.33 years NPVA = $98.31 Cummulative ATCF Year O -200 -200 Year O -200 -200 Payback period = 2 + 40/80 = 2.5 years NPVB = $68.17 Year 1 $80 Year 1 0 -200 at i* = 15% Year 1 80 -120 Year 2 - $80 Year 2 0 -200 Year 2 80 -40 Year 3 1 $80 Year 3 0 -200 Year 3 80 40 Year 4 $80 Year 4 0 -200 Year 4 80 120 Year 5 $600 $80 Year 5 600 400 Year 5 80 200 at i* = 15% Answer: Although Project B has a lower payback period (2.5 years). However, Project A with a payback period of 4.33 years is more attractive for investment as it has a better NPV. 7

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