Finance BU393 Assignment 1 - Problem 1 a) Payback Period =...

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Problem 1 a) Payback Period = 2 years Project X has a payback period of 1.88 years (1+1500/1700) Project Y has a payback period of 1.98 years (1+2950/3000) Project Z has a payback period of 1.79 years (1+ 950/1200) Thus, all alternatives are acceptable under the payback period method. Discounted Payback period = 3 years (Numbers in brackets are the discount rate) Money to be received at the end of the year (round up) Year Project X Project Y Project Z 0 –$4,500 –$4,650 –$2,200 1 $3,000 (2666.67) $1,700 (1511.11) $1250 (1111.11) 2 $1,700 (1343.20) $3,000 (2370.37) $1200 (948.15) 3 $1,000 (702.33) $1,500 (1053.49) $420 (294.98) Project X has a discounted payback period of 2.698 (2 years + 490.13/702.33) = 3 years Project Y has a discounted payback period of 2.729 (2 years + 768.52/1053.49) = 3 years Project Z has a discounted payback period of 2.477 (2 years + 140.74/294.98) = 3 years Thus, all alternatives are acceptable under the discounted payback period method. b) IRR Project X = -$4500 + (3000/1+IRR) + (1700/(1+IRR) ^2 ) + (1000/(1+IRR) ^3 ) = 0 IRR = 15.8439% using excel IRR function Project Y = -$4650 + (1700/1+IRR) + (3000/(1+IRR) ^2 ) + (1500/(1+IRR) ^3 ) = 0 IRR = 16.0790% using excel IRR function Project Z = -$2200 + (1250/1+IRR) + (1200/(1+IRR) ^2 ) +(420/(1+IRR) ^3 ) = 0 IRR = 17.2351% using excel IRR function IIRR We begin by comparing the two biggest projects: Project Y – Project X = -4650 – (-4500) = -150 at year 0, 1511.11 -2666.67 = -1155.56 at year 1, 2370.37-1343.21 = 1027.16 at year 2 and 1053.497-702.33 = 351.167 IIRR = -150 + (-1155.56/1+IIRR) + (1027.16/(1+IIRR) ^2 ) + (351.167/(1+IIRR) ^3 ) = 0 IIRR = %4.0445 Thus, Project X is preferred using the IIRR of %4.0445 < 12.5% rate of return (k) over project Y. It is now time to compare project X with project Z. Project X – Project Z = -4500 – (-2200) = -2300 at year 0, 2666.67-1111.11 = 1555.56 at year 1, 1343.2 – 948.148 = 395.052 at year 2 and 702.33 – 294.979 =407.351 at year 3 IIRR = -2300 + (1555.56/1+IIRR) + (395.052/(1+IIRR) ^2 ) + (407.351/(1+IIRR) ^3 ) = 0 IIRR = %1.66 Thus, project Z is preferred because using the IIRR of %1.66 < 12.5% rate of return (k) over project X. Now compare Project Y with project Z.
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Project Y – Project Z = -4650 – (-2200) = -2450 at year 0, 1511.11- 1111.11= 400 at year 1, 2370.37 – 948.148= 1422.22 at year 2 and 1053.498 - 294.979 = 758.519 at year 3 IIRR = -2450 + (400/1+IIRR) + (1422.22/(1+IIRR) ^2 ) + (758.519/(1+IIRR) ^3 ) = 0 IIRR = %2.47 Thus, project Z is preferred using the IIRR of %2.47 < 12.5% rate of return (k) over project Y. Overall, using IIRR, the ranking of projects starts off with project Z being the best, then project X, then project Y. c)
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This note was uploaded on 10/15/2011 for the course BUSINESS bu393 taught by Professor - during the Spring '11 term at Wilfred Laurier University .

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Finance BU393 Assignment 1 - Problem 1 a) Payback Period =...

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