Problem 12a- The Project Payback Period represents the amount of time that it takes for a Capital Budgeting project to recover its initial cost. The numbers represented in the table are equivalent to Caladonia Products cash flow. Both projects start out with -100,000, yet project A consistently shows a $32,000 for the next five years. The payback period is formulated with the following : [pic]. With the NCF equaling the Net Cash Flow. Given those stats for Project A, the last year with a negative is year 1 so it would be -100,000/32,000=3.125, so the pay back period for project A is 3.12 years. Project B is a little more difficult because there is no cash flow listed in years 1-4, yet year 5 has a value of $200,000. Dividing the 4 missing years by 200,000 will give you an avg cash flow of $50,000. The last negative year produced $-100,000 divide that by $50,000 will give you -2. So the pay back period is 2 years for Project B.
The NPV is calculated as the present value of the project's cash inflows minus the present value of the project's cash outflows. This relationship is expressed by the following formula:
[pic] (zenwealth, 2008)
Both projects started with a -100,000. So using the above formula, Project A has a NPV of 18,268.7.
Project B, with using the estimated cash flow of 50,000 comes to a NPV of 84,794.85. Both of these problems used 11% return rate.
12c. Internal rate of return
The internal rate of return for project A is 10.661% while the internal rate of return for project B is 18.920%. Project A would be at just below the required 11% rate of return to go forward with the project but Project B goes above and beyond that with close to 19% and will be the company’s preference of a capital gains venture.
12d. Ranking Conflict
The cause of “ranking conflict” was generated by the estimated cash flow within project “B”
Project “B” would be the choice for 3 reasons
- Project B has a larger rate of return...