Calculate IRR, NPV and Payback Period
Analyze the cash flows generated by mutually exclusive projects
Formulate a recommendation using IRR, NPV and Payback Period as the criteria
Background
Suppose that your firm is considering the following two mutually exclusive projects. Both projects have the same initial cost of $312,500 and the resulting annual cash flows for the first five years are as shown in the table below:
|
Year
|
Alpha
|
Beta
|
|
0
|
$ (312,500)
|
$ (312,500)
|
|
1
|
375,000
|
28,935
|
|
2
|
46,875
|
80,376
|
|
3
|
15,625
|
99,229
|
|
4
|
15,625
|
160,788
|
|
5
|
3,125
|
191,414
|
It is your job to analyze the feasibility of these two projects and to make recommendations as to which project should be undertaken. You must present a written report of your findings and your recommendations to middle managers, many of whom may be unfamiliar with some of your computations. You may choose to present the results of your calculations in table form. In your report, you must address each of the following:
Analyses:
a. Calculate the IRR of each project. Which project should be selected using IRR as the criterion?
b. In its analyses of projects of this type, your firm uses a 14.0 percent discount rate. Compute the NPV for each project using the 14.0 percent discount rate. Which project should be chosen based on this result?
c. In some cases, your firm uses the payback period to assess projects, with a cut-off point of 3 years. Calculate the payback period for each project and explain which project should be chosen using this criterion.