# tutorial - PARTA 1 A firm is considering two mutually...

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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

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Since only \$4958need to be recovered in Year 2 while the cash inflow is \$6000, the investment would be recovered in a fraction of Year 2. To calculate this fraction we divide \$4958 by \$6,000 = 0.82.
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## This note was uploaded on 01/05/2012 for the course 101 melissa jo taught by Professor Acc101 during the Spring '11 term at Aarhus Universitet.

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tutorial - PARTA 1 A firm is considering two mutually...

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