All techniques with NPV profile- mutually exclusive projects.

Question

Projects A and B, of equal risk. Are alternatives for expanding Rosa Company’s capacity. The firm’s cost of capital is 13%. The cash flows for each project are shown in the following table.
a. Calculate each project’s payback period.
b. Calculate the net present value (NPV) for each project.
c. Calculate the internal rate of return (IRR) for each project.
d. Draw the net present value profiles for both projects on the same set of axes, and discuss any conflict in ranking that may exist between NPV and IRR.
e. Summarize the preferences dictated by each measure, and include which project you would recommend. Explain why.

Answer 1

a.Project A
Payback period
Year 1 + Year 2 + Year 3 = $60,000
Year 4 + $20,000
Initial investment = $80,000
Payback=3 years + ($20,000 / 30,000)
Payback =3.67 years
Project B
Payback period
$50,000/ $15,000 = 3.33 years
B.
Project A
CF0 = -$80,000; CF1= $15,000; CF2= $20,000; CF3= $25,000; CF4= $30,000;
CF5 =$35,000
Set I = 13%
Solve for NPVA = $3,659.68
Project B
CF0 =-$50,000; CF1 = $15,000; F1 = 5
Set I= 13%
Solve for NPVB = $2,758.47
c. Project A
CF0=-$80,000; CF1 = $15,000; CF2= $20,000; CF3= $25,000; CF4=$30,000;
CF5= $35,000
Solve for IRRA= 14.61%
Project B
CF0=$50,000; CF1= $15,000; F1=5
Solve for IRRB= 15.24%

D. It's a Graph. (You must Make It)
Data for NPV Profiles
NPV
Discount Rate A B

0% $45,000 $25,000
13% $3,655 2,755
14.6% 0 —
15.2% — 0
Intersection—approximately 14%
If cost of capital is above 14%, conflicting rankings occur.
The calculator solution is 13.87%.

E.
Both projects are acceptable. Both have similar payback periods, positive NPVs, and equivalent IRRs that are greater than the cost of capital. Although Project B has a slightly higher IRR, the rates are very close. Because Project A has a higher NPV, accept Project A.