Question 1: X-treme Vitamin Company is considering two investments, both of which cost $10,000. The cash flows are as follows:
Year Project A Project B
1 $12,000 $10,000
2 8,000 6,000
3 6,000 16,000
a. Which of the two projects should be chosen based on the payback method?
b. Which of the two projects should be chosen based on the net present value method? Assume a cost of capital of 10 percent.
c. Should a firm normally have more confidence in answer a or answer b?
Question 2: The Danforth Tire Company is considering the purchase of a new machine that would increase the speed of manufacturing and save money. The net cost of this machine is $66,000. The annual cash flows have the following projections.
Year Cash Flow
a. If the cost of capital is 10 percent, what is the net present value?
b. What is the internal rate of return?
c. Should the project be accepted? Why?