FIN622 Solution May 11,2010

[Guru]

SOLUTION

1) The payback period of each project



THE PAYBACK PERIOD (PP); For the Project A that has equal receipts



= Initial Investment / Cash Flow (I0/Ct)

= 57000/20000

= 2.85year



THE PAYBACK PERIOD (PP); For the Project B



Payback period lie between 2nd year and 3rd year

Sum of the money recovered by the end of second year

= (22000+20000)

= 42000



Sum of money recovered by the end of 3rd year

= (54000 – 42000)

= 12000

= [2+ 12000/18000) years

= 2.667 years



2) The Net present value (NPV) of each project.



NPV for project A;

Formula:

(CFn * PVFA at 14% for 4 years) – Initial Investment



PVFA at 14% for 4 years:



= [1/ (1+i) ^ n + 1/ (1+i) ^ n + 1/ (1+i) ^ n + 1/ (1+i) ^ n]



= [1/ (1+0.14) ^1 + 1/ (1+0.14) ^2 + 1/ (1+0.14) ^3 + 1/ (1+0.14) ^4]



= [0.8772 + 0.7695 + 0.6749 + 0.5920]

= [2.9136]



By putting values in Formula:

= (20000 * 2.9136) – 57000

= 1272



NPV for project B;

Formula:

Sum of the NPV (CFn) – Initial investment



Sum of the NPV (CFn)

= [CF1/ (1+i) ^ n + CF2/ (1+i) ^ n + CF3/ (1+i) ^ n + CF4/ (1+i) ^ n]



= [22000/ (1+0.14) ^1 + 20000/ (1+0.14) ^2 + 18000/ (1+0.14) ^3 + 16000/ (1+0.14) ^4]

= 19298.246 + 15389.352 + 12149.487 + 9473.284

= 56310.368

By putting values

= 56310.368 – 54000

= 2310.368



3) Decision


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