XYZ Ltd has got up to Rs. 60000 to invest. The following proposals are under consideration.
Project initial outlay Annual cash inflow Life in years
A 40000 8000 8
B 10000 4000 3
C 20000 8000 5
D 24000 6000 10
E 30000 5000 15
F 4000 2000 2
G 16000 4000 11
- Rank the projects in order of their desirability according to payback period method.
- Rank the project under NPV method assuming the cost of capital to be 15%
- Explain any inconsistencies between method (a) and (b)
1
Ans.
Discount factor = 1/(1+r)n
PV factor for 15% for 1st year = 1/(1+ 15/100)1 = 1 / 100+15 = 0.869
100
2nd year = 0.755
3rd year = 0.657
4th year = 0.571
5th year = 0.497
6th year = 0.432
7th year = 0.376
8th year = 0.326
9th year = 0.284
10th year = 0.247
11th year = 0.214
12th year = 0.187
13th year = 0.163
14th year = 0.141
15th year = 0.122
Pay back period method
Project initial outlay Annual cash flow PBP Rank
A 40000 8000 5 4
B 10000 4000 2.5 2
C 20000 8000 2.5 2
D 24000 6000 4 3
E 30000 5000 6 5
F 4000 2000 2 1
G 16000 4000 4 3
NPV Method
NPV = Total cash inflow – initial investment
Project cash inflow discount PV of Initial NPV Rank
Factor Cash inflow Investment ——————
A 8000 4.4873 35898.4 40000 – 4102 rejected
B 4000 2.2822 9128 10000 – 872 rejected
C 8000 3.3522 26817 20000 6817 1
D 6000 5.014 30084 24000 6084 2
E 5000 5.842 29210 30000 -790 rejected
F 2000 1.625 3250 4000 -750 rejected
G 4000 5.228 20912 16000 4912 3
- c) Under payback method project F is given 1st rank where as it is rejected under NPV method. Project B is given 2nd rank and it is rejected under NPV method.
