Question 1

A company has two projects to choose from with the following annual after-tax cash flows:

Project A

Investment (today)$700,000

Investment (Year 1) $400,000

Years 28$600,000

Project B

Investment (today)$1,600,000

Years 18$750,000

The firm's cost of capital is 15 percent.

Compute both projects' payback period and discounted payback period.(4 marks)

Question 2

The R.M. Company uses the following risk-adjusted discount rates for capital budgeting purposes:

Investments in new product lines16%

Substitution of labour with capital (machinery)10%

Expansion of existing product lines12%

Replacement of existing equipment8%

The firm has $500,000 of available capital for investment .Project A involves the production of a brand new product line.Project B involves the replacement of existing machinery.Project C involves the purchase of a more sophisticated piece of equipment as a replacement for existing machinery.This more sophisticated machine will enable R.M. Company to reduce the size of its workforce.There are no other projects available at this time.

Expected cash flows for these independent projects are as follows:

Projects

ABC

(in thousands of dollars)

Investment (today)400500100

Net after-tax cash inflows

Year 116013030

Year 215015040

Year 314018050

Year 413021060

Which project(s) would you recommend the company undertake?Show your calculations and provide any necessary explanations