Finance help! please!

Question

Caledonia is considering two additional mutually exclusive projects. The cash flows associated with these projects are as follows:

YEAR PROJECT A PROJECT B

0 –$100,000 –$100,000

1 32,000 0

2 32,000 0

3 32,000 0

4 32,000 0

5 32,000 $200,000

The required rate of return on these projects is 11 percent

A. What is each projects payback period?

Would I do -100,000 / 32,000 for Project A? and -100,000 / 200,000 for project B? Or am I totally wrong?

B. find the net present value for each project?

I need help with present value for each project. thank you!

Answer 1

Project A:

Net present value is found by taking the original investment cost, $100,000 (that would be a negative amount since it's cash out the door), and then adding the present value of the annual cash inflows expected ($32,000 for 5 years at the required rate of return of 11%). You look up in the present value annuity table the factor for 5 years at 11%, which is 3.696, and multiply by 32,000 to get present value of expected cash inflows = $118,272.

Net present value = $118,272 - $100,000 = $18,272

Payback period is the time that it takes a project to recover its initial cost from the revenue it generates.

Payback period = Investment required / Net annual cash inflow

= $100,000 / $32,000 = 3.125 years.

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Project B:

In this one, there are no annual cash inflows, just the one inflow of $200,000 in year 5. So you need to find the present value of $200,000 five years from now at 11%. You don't use the annuity table for this one, you use the present value of $1 table. The factor this table gives is 0.593. So the present value of $200,000 five years from now at 11% is $200,000 * 0.593 = $118,600.

Net present value = $118,600 - $100,000 = $18,600

The payback period for this project is five years. It's not until the cash inflow of $200,000 in year 5 that the project recovers its original cost.