Question
A firm faces two alternative investment projects A and B and wants to choose one of them. The relevant information for these projects is as
A firm faces two alternative investment projects A and B and wants to choose one of them. The relevant information for these projects is as follows:
Project A:
Cost of Investment: $ 10 000 000 (paid in 2021)
Lifetime: 6 years
Expected Cash Flows:
2022: $ 4 000 000
2023: $ 6 000 000
2024 $ 6 000 000
2025 $ 4 500 000
2026 $ 3 500 000
2027 $ 3 000 000
The firm do not expect any salvage value in that investment (expected salvage value of Project A is 0)
Project B:
Cost: $ 10 000 000 (paid in 2021)
Lifetime: 6 years
Expected Cash Flows:
2022: $ 3 000 000
2023: $ 5 000 000
2024: $ 5 000 000
2025: $ 6 000 000
2026: $ 6 500 000
2027: $ 5 000 000
The firm expects to have a salvage value of $ 2 000 000 in 2027 for Project B.
Firm uses a discount rate of 10% for both project A and project B.
a) Calculate exact payback period of Project A and Project B using Simple Payback Method.
b) Assume that the desired payback period for the Simple Payback Method is 2.5 years for Project A and also for Project B. Which one of the projects will be chosen by the firm in that case?
c) Calculate the exact payback period of both Project A and Project B using Discounted Payback Period.
d) Assuming that the desired payback periods of both Project A and Project B is 2.5 years; which one of the projects will be chosen by that firm if that firm uses Discounted Payback Method to evaluate these investments?
e) Calculate the net PV of Project A and Project B. Which project will be chosen by the firm if the firm uses net PV method to evaluate the investments?
f) Do these three methods choose the same investment as the better investment? If not; then which methods choice must be accepted by the firm?
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