As the director of capital budgeting for Denver Corporation, you are evaluating two mutually exclusive projects. Project X is a three year project and project Z is a four year project. The project net cash flows are followed:
Project X Project Z
Year Cash Flow Cash Flow
0 -$200,000 -$300,000
1 70,000 50,000
2 120,000 80,000
3 140,000 100,000
4 270,000
Denver's cost of capital is 15 percent.
1. What is project Z's payback period? If the cut off period for the company is 3 years, will you accept project X?
2. What is project X's discounted payback period? If the cut off period for the company is 3 years, will you accept project Z?
3. What is each project's NPV? Which project would you choose based on NPV rule?
4. What is each project's IRR? Which project would you choose based on IRR rule?
5. Why IRR rule and NPV rule lead to different decisions? Which rule is more appropriate to evaluate mutually exclusive projects? Why?
6. What is each project's profitability index? Based on profitability index, which project would you choose?
7. What is each project's Equivalent Annual Annuity (EAA)? Based on EAA, which project would you choose?
8. Which project evaluation rule is the most appropriate one to use for selecting these two projects? Why?