Question

Giant Machinery Ltd is considering to invest in one of the two following Projects to buy a new equipment. Each project will last 5 years and have no salvage value at the end. The company’s required rate of return for all investment projects is 9%. The cash flows of the projects are provided below.

Project 1 Project 2 Cost $175, 000 $185 ,000 Future Cash Flows Year 1 Year 2 Year 3 Year 4 Year 5 76 ,000 83 ,000 67 ,000 65 ,000 55 ,000 87 ,000 78 ,000 69 ,000 65 ,000 57 ,000 Required: a) Identify which project should the company accept based on NPV method .(Note: Please round up the result of each calculation of PV to 2 decimal places only for simplification)
b) Identify which project should the company accept based on simple pay back method if the payback criteria is maximum 2 years .
c) Which project Giant Machinery should choose if two methods are in conflict .

Answer 1

a) Identify which project should the company accept based on NPV method.

• Project 2 has a higher NPV = $98,960

b) Identify which project should the company accept based on simple pay back method if the payback criteria is maximum 2 years.

• Project 2 has a shorter payback period = 2 years and 5 months

c) Which project Giant Machinery should choose if two methods are in conflict.

• If two projects are in conflict, then you must choose the project based on their NPV.

Step-by-step explanation:

Project 1 Project 2

Cost $175, 000 $185 ,000

Future Cash Flows

Year 1 $76,000 $83,000

Year 2 $67,000 $65,000

Year 3 $55,000 $87,000

Year 4 $78,000 $69,000

Year 5 $65,000 $57,000

NPV:

Project 1 = -175000 + 76000/1.09 + 67000/1.09² + 55000/1.09³ + 78000/1.09⁴ + 65000/1.09⁵ = $91,090

Project 2 = -185000 + 83000/1.09 + 65000/1.09² + 87000/1.09³ + 69000/1.09⁴ + 57000/1.09⁵ = $98,960

Payback:

Project 1 = -175000 - 76000 - 67000 = 32000 after 2 years, then 32000 / 55000 = 7 months

Project 2 = -185000 - 83000 - 65000 = 37000 after 2 years, then 37000 / 87000 = 5 months