Caledonia Products Integrative Problem
Part A. What is each project’s payback period?
Payback period = Investment required / Net Annual Cash Inflow
Project A: 100,000 / 32,000 = 3.125 years
Project B: 5 years. There is no cash inflow until the fifth year when an inflow of $200,000 comes in to offset the investment.
To determine payback period it is the following:
Payback Period = Y + ( A / B ) where
Y = The number of years before final payback year.
A = Total remaining to be paid back at the start of the payback year, to bring cumulative cash flow to
B = Total (net) paid back in the entire payback year
For first case
Y=3 (we see in year 4 it is paid back so 3 is year ...view middle of the document...
Part E. Which project should be accepted and why?
Net Present Value
1. Project A = -100000 + ∑ 32000 (1.15) pwr t = $18268
Project B = -100000 + 200000(1.15) pwr 5 = $18690
Internal Rate Return
2. Project A 0 = -100000 + ∑ 32000 (1+r) pwr t
R = 18%
Project B 0 = -100000 + 200000(1+r) pwr 5
R = 15%
Project A demonstrates a positive net present value and a higher rate of internal rate return than Project B.
Caledonia should accept Project A because of the following reasons:
a) Project A has a lower payback period compared to that of Project B’s payback, which means it is able to recoup the investments earlier than Project B.
b) Even as per the IRR decision criteria both can be accepted as both the Projects have their IRR > Cost of Capital. But still if one of it needs to be selected then we must accept Project A as it is having a higher IRR then Project B’s IRR, i.e. 18% > 15%. So, Project A should be accepted.
c) Even though as per the NPV decision criteria, Project B should be accepted as it is having a higher NPV of $18,690, whereas...