Question
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
- Calculate the pay back period for each project and advise (3 Marks)
- Calculate the discounted pay back for each project and advise (3 Marks)
- Calculate the Net Present Value for each project and advise (5 Marks)
- Calculate Internal Rate of Return for each project and advise (5 Marks)
- Calculate profitability index for each project and advise (3 Marks)
- 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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