Your boss, the chief financial officer (CFO) for Southern Textiles, has just handed you the estimated cashflows for two proposed projects. Project L involves adding a new item to the firms fabric line. It would take some time to build up the market for this product, so the cash inflows would increase over time. Project S involves an add-on to an existing line, and its cash flows would decrease over time. Both projects have 3-year lives because Southern is planning to introduce an entirely new fabric at that time.

Expected Net Cash Flows

Year Project L Project S

0 $(100) $(100)

1 10 70

2 60 50

3 80 20

The CFO also made subjective risk assessments of each project, and he concluded that the projects both have risk characteristics that are similar to the firms average project. Southerns required rate of return is 10%. You must now determine whether one or both of the projects should be accepted.

c.

(1) What is the payback period? Find the traditional payback periods for Project L and Project S.

(2) What is the difference between the traditional payback and the discounted payback? What is

each projects discounted payback?

(3) What are the main disadvantages of the traditional payback? Explain which project has the better

payback period.

d.

(1) Define the term net present value (NPV). What is each projects NPV?

(2) Define the term internal rate of return (IRR). What is each projects IRR?

e. Which is the better project according to NPV and IRR?