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A company uses only debt and equity. It can borrow unlimited amounts at a cost of 10.4% as long as it finances at its target

A company uses only debt and equity. It can borrow unlimited amounts at a cost of 10.4% as long as it finances at its target capital structure, which calls for 40% debt and 60% common equity. Two mutually exclusive projects are being considered. Both projects are expected to have zero scrap value at the end of 5 years. The projects expected net cash flows are as follows:

YEAR PROJECT A PROJECT B

0 (4000) (6000)

1 550 3,000

2 550 3,000

3 550 500

4 2250 500

5 2,250 500

Required

  1. Calculate the pay back period for each project and advise (3 Marks)
  2. Calculate the discounted pay back for each project and advise (3 Marks)
  3. Calculate the Net Present Value for each project and advise (5 Marks)
  4. Calculate Internal Rate of Return for each project and advise (5 Marks)
  5. Calculate profitability index for each project and advise (3 Marks)
  6. Calculate Accounting Rate of Return for each project and advise. (3 Marks)

Based on the above calculations, which project should the company undertake and why?

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