PART A
1) A firm is considering two mutually exclusive investments, each with an initial outlay
of $100,000 and an expected life 3 years. Assume that the firm has of capital of 10
percent for each project. The two investments are of equal risk and have the following
cash flows:
Investment A Investment B
Year 0 -$100,000 -$100,000 Year 1 $40,000 $55,000 Year 2 $50,000 $55,000 year 3
110,000 55,000
Calculate the payback period and the net present value for each investment. SHOW
YOUR CALCULATIONS
Based on the NPV and payback period calculations, which investment should the firm
choose? Why?
NPV - Investment A
Year
Cash Flow
PV Factor @ 10%
PV
0
($10,000)
1
($10,000)
1
$4,000
0.9091
$ 3636
2
$5,000
0.8264
$ 4132
3
$11,000
0.7513
$ 8264
NPV
$6,032
Payback Period - Investment A
Year Beginning Unrecovered Investment
Cash Flow
Ending Unrecovered Investment
0
$10,000
$10,000
$10,000
1
$10,000
$4,000
$6000
2
$6,000
$5,000
$1,000
3
$1,000
$11,000
($10,000)
Since only $1,000 need to be recovered in Year 3 while the cash inflow is $11,000,
the investment would be recovered in a fraction of Year 3.
To calculate this fraction
we divide $1,000 by $11,000 = 0.090.
The payback period = 3.090 years
NPV - Investment B
Year
Cash Flow
PV Factor @ 10%
PV
0
($10,000)
1
($10,000)
1
$6,000
0.9091
$ 5454
2
$6,000
0.8264
$ 4958
3
$6,000
0.7513
$ 4508
NPV
$4,920