Answer to Question #197493 in Finance for Kajal

Question

Org Pvt. Ltd. is considering two mutually exclusive capital investments. The project’s

Expected cash flows

year

Project A

Project B

0

-400

-575

1

95

150

2

110

200

3

118

250

4

125

275

5

140

230

6

150

180

expected net cash flows are as follows:

a. If you were told that each project’s cost of capital was 10%, which project should be

selected using the NPV criteria?

b. What is each project’s IRR?

c. What is the regular payback period for these two projects?

d. What is the profitability index for each project if the cost of capital is 12%?

Answer 1

a.

In case of mutually exclusive projects company can select one project at a time. Selection of one project will lead to automatic rejection of other project.

Answer: Select project B as the NPV is more when compared to project A.

Formulas:

b.

Before investing in new assets or projects, profitability is evaluated by using various methods like NPV, IRR, Payback period etc. This is capital budgeting.

Result of above table:-

IRR for project A is 19.12%

IRR for project B is 27.54%

c.

Pay back period for project A is 3.616 years

Payback period for project B is 2.90 years

d.

Profitability index for project A is 1.2284

Profitability index for project B is 1.5092