L M N 0 A B D E G 3 Assume that you are the CFO at Porter Memorial Hospital. The CEO has asked you to analyze two proposed 4 capital investments - project X and project Y. Each project requires a net investment outlay of $10,000, 5 and the cost of capital for each project is 12 percent. The projects' expected net cash flows are as follows: 6 7 Year Project X Project Y Rate 8 0 S (10,000) S (10,000) 12.0% 9 1 S 6,500 S 3,000 10 2 S 3,000 S 3,000 11 3 S 3,000 S 3,000 12 4 s 1,000 $ 3,000 13 14 a. Calculate each project's payback period, net present value (NPV), and the internal rate of return (IRR). 15 16 b. Which project is financially acceptable? Explain your answer. 17 18 19 ANSWER Project X Project Y 20 a. X Y S (10,000) S (10,000) 21 Payback 2.17 3.33 Years S (3,500) S (7,000) 22 NPV $966.01 (5887.95) S (500) S (4,000) 23 IRR 18.0% 7.7% S 2,500 S (1,000) 24 $ 3,500 $2,000 25 b. 26 Project X has a positive NPV (and its IRR is greater than the 12 percent cost of capital), while Project Y 27 has a negative NPV (and an IRR that is less than its cost of capital). Therefore, Project X is financially 28 acceptable while Project Y is not. The payback tells us that Project X is more liquid (and perhaps less 29 risky) than Project Y, but it does not indicate financial acceptability. 30 31 32 33 34