Question:

You are a financial analyst for the Hittle Company. The director of capital budgeting has asked you to analyze two
proposed capital investments, Projects X and Y. Each project has a cost of $10,000, and the cost of capital for each
project is 12 percent. The projects" expected net cash flows are as follows:

Calculate each project’s payback period, net present value (NPV), internal rate of return (IRR), and modified internal
rate of return (MIRR).

Which project or projects should be accepted if they are independent?

Which project should be accepted if they are mutually exclusive?

How might a change in the cost of capital produce a conflict between the NPV and IRR rankings of these two
projects? Would this conflict exist if r were 5%? (Hint: Plot the NPV profiles.)

Why does the conflict exist?

Solution:

a. Payback: PROJECT X: Cost of project = Rs. 10,000

Payback period is the time required by the project to recover its costs.

Year 1 the project will recover Rs. 6,500

Year 2 the project will recover Rs 3000

Year 3 project will recover 3000/12 = Rs. 250 / Month, So the remaining Rs. 500 will recover in 2nd month of 3rd yr.

So payback period for Project X is 2 yrs and 2 month.

Payback: PROJECT Y: Cost of project = Rs. 10,000

Payback period is the time required by the project to recover its costs.

Year 1 the project will recover Rs. 3,500

Year 2 the project will recover Rs. 3,500

Year 3 project will recover 3500/12 = Rs. 292 / Month, So the remaining Rs. 3000 will recover in 10.28th month of
3rd yr.

So payback period for Project Y is 2 yrs and 10.28 months.

Project X:

NPV = - I0 + CF1/(1+i)n + CF2/(1+i)n + CF3/(1+i) n + CF4/(1+i) n

= -10,000 + 6500/(1.12) + 3000/(1.12)2+ 3000/(1.12)3+ 1000/(1.12)4

= Rs. 966

Project Y:

NPV = - I0 + CF1/(1+i)n + CF2/(1+i)n + CF3/(1+i) n + CF4/(1+i) n

= -10,000 + 3500/(1.12) + 3500/(1.12)2+ 3500/(1.12)3+ 3500/(1.12)4

= Rs. 631

Project X:

NPV = - 10000 + 6500/(1+i) + 3000(1+i)2+ 3000(1+i) 3+ 1000/(1+i) 4

Put i = 15%, NPV = 465

Put i = 16%, NPV = 307

Put i = 17%, NPV = 154

Put i = 18%, NPV = 4 -> 0

Therefore IRR = 18%

Project Y:

NPV = - 10000 + 3500/(1+i) + 3500(1+i)2+ 3500(1+i) 3+ 3500/(1+i) 4

Put i = 14%, NPV = 198

Put i = 15%, NPV = -8 -> 0

Therefore IRR = 15%

b. Both Projects Should be accepted if they are independant because they have Positive NPV and IRR greater than
12% Cost Of Capital

c. In case of mutually exclusive, Project X should be chosen