You are helping your company make a capital budgeting decision. Projects A and B are mutually exclusive
Question:
You are helping your company make a capital budgeting decision. Projects A and B are mutually exclusive projects and have the following projected after-tax cash flows. The company has determined that the proper discount rate for the project is 9%. The target payback period and discount payback period are 3 years and 2 years respectively.
Project A | Project B | |
Year 0 | (400,000) | (100,000) |
Year 1 | 50,000 | 50,000 |
Year 2 | 70,000 | 6,000 |
Year 3 | 72,000 | 66,000 |
Year 4 | 420,000 | 80,000 |
Calculate the payback period, discounted payback period, net present value, internal rate of return and profitability index for each project. Based on each individual measure, what are your recommendations?
Criteria | Project A Result | Project B Result | Recommendation? |
Payback Period | |||
Discounted Payback Period | |||
Net Present Value | |||
Internal Rate of Return | |||
Profitability Index |
Based on all five measures taken together, what is your recommendation? If the projects were not mutually exclusive, would your recommendation change? If the discount rate decreases to 8%, how will each of these measures be impacted? Will each increase or decrease or remain the same?
Criteria | Increase/Decrease/Remain the Same |
Payback Period | |
Discount Payback Period | |
Net Present Value | |
Internal Rate of Return | |
Profitability Index |
Foundations of Finance The Logic and Practice of Financial Management
ISBN: 978-0132994873
8th edition
Authors: Arthur J. Keown, John D. Martin, J. William Petty