Tutorial 8 Solutions

Yea
Cashflows A Cashflows B PV Project A PV Project B Cost of Capital
r
-200.00 -200.00
0 -200 -200 11%
72.07 90.09
1 80 100
64.93 81.16
2 80 100
58.50 73.12
3 80 100
52.70
4 80
48.20 44.37

1.
a. 48.20 and 44.37
b. Both as both have positive NPV.
c. Choose A.

-200.00 -200.00
16%
68.97 86.21

59.45 74.32

51.25 64.07

44.18

23.85 24.59

d. In this case choose B.

2. IRRA = 21.86%, IRRB = 23.38%

3. It depends. Even though project B has the higher IRR, its NPV is lower than that of project A when the
discount rate is lower and higher when the discount rate is higher. This example shows that the project with
the higher IRR is not necessarily better. The IRR of each project is fixed, but as the discount rate increases,
project B becomes relatively more attractive compared to project A. This is because B’s cash flows come
earlier, so the present value of these cash flows decreases less rapidly when the discount rate increases.

4. The profitability indices are as follows:

 Project A: $48.20/$200 = 0.2410
Project B: $44.37/$200 = 0.2219

5. Project A has a payback period of 3 years. Project B has a payback period of 2 years.

Not necessarily. Despite its longer payback period, Project A may still be the preferred
project, for example, when the discount rate is 11%. The payback period for each project is
fixed but the NPV changes as the discount rate changes. The project with the shorter
payback period need not have the higher NPV.
6. 4 years and 3 years.