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The manager of a local company has to choose between the two projects below
The manager of a local company has to choose between the two projects below. The required rate of return is 10%.
Year Project A
-
0 -359000
-
1 95000
-
2 108000
-
3 90000
-
4 80000
-
5 20000
Project B -276000 40000 83000 105000 128000 148000
What is payback period for each project?
What is the IRR for each project?
Which project shall the manager choose?
Expert Solution
Project's Payback Period = Years before recovery + Cost not covered in that year/ Cash flow for that year
Payback Period of Project A =3+(359000-95000-108000-90000)/80000 =3.825
Payback Period of Project B =3+(276000-40000-83000-105000)/128000 =3.375
IRR of Project A can be calculated using financial calculator
CF0=-359000;CF1=95000;CF2=108000;CF3=90000;CF4=80000;CF5=20000;CPT IRR =3.65%
IRR of Project B can be calculated using financial calculator
CF0=-276000;CF1=40000;CF2=83000;CF3=105000;CF4=128000;CF5=148000;CPT IRR =19.58%
The Manager should choose Project B as IRR of 19.59% is greater than cost of capital of 10%.
The Manager should reject Project a as IRR of 3.65% is less than cost of capital of 10%.
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