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Homework answers / question archive / Your company is presented with two proposals, ABC and XYZ, with equal risks that require initial investments of $95,000 and $100,000 respectively
Your company is presented with two proposals, ABC and XYZ, with equal risks that require initial investments of
$95,000 and $100,000 respectively. Assume a cost of capital of 14%. Subsequent a fter tax end-of-year net cash inflows are given as follows:
Year Proposal ABC Proposal XYZ
1
$32,500
$30,000
2
35,000
30,000
3
35,000
30,000
4
35,000
30,000
Required:
*****READ VERY CAREFULLY*****
1) (10 marks)
(a) Place your answer for each of the proposals by ranking method in the table below.
(b) For each ranking method, what is the better choice? "ABC" or "XYZ"? Circle the better choice. (There should be only ONE answer circled PER row.)
Ranking Method
"Proposal ABC"
"Proposal XYZ"
Payback periods
Net Present Value
Internal Rate of Return
Profitability Index
2) (2 marks)
If mutually exclusive projects are being evaluated, NPV and IRR criteria may not always lead to the same accept/reject decision. Explain. (Marks will be awarded on the basis of explanation.)
1). Payback period for proposal ABC = 2.79 years
For proposal XYZ = 3.33 years
NPV for proposal ABC = $4,786.95
For proposal XYZ = -$12,588.63
IRR for proposal ABC = 16.41%
For proposal XYZ = 7.71%
PI for proposal ABC = 1.05
For proposal XYZ = 0.87
2). The NPV and IRR methods can lead to conflicting decisions for mutually exclusive projects because of cash flow timing and size differences between projects. For mutually exclusive projects NPV method is used rather than using IRR. NPV is an absolute measure, it is the dollar amount of value added or lost by undertaking a project, whereas the IRR, is a relative measure, it is the rate of return that a project offers over its lifespan.
