Case Study 6

Projects A and Project B have similar initial outlays but different patterns of future cash flows.

Project A will generate a cash inflow of 80,000 in year one, cash outflow of 20,000 in year two, and cash inflow of 85,000 from year three to year five.

Project B will require spending of 30,000 on year one, cash inflow of 105,000 in year two, and year three, cash inflow of 60,000 in year four and year five. The required rate of return is 11.5 percent.

You are required to:

(a)Determine the net present value (NPV) and internal rate of return (IRR) for both projects.(6marks)

(b)Calculate the profitability index (PI) for each project.

(4 marks)

(c)If the two projects were a mutually exclusive project, which projects would you invest? Justify your answers.(2marks)

(d)If the two projects were not a mutually exclusive project, which project would you invest? Justify your answers.(2 marks)

(e)Decision makers faced difficulties when encountered mutually exclusive projects. Discuss these problems.(6marks)