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Question - Star is a company that has been making profit for the previous three years and wishes to maximise resources by investing into profitable projects. Star is considering two investment projects as follows:
The cash flows for each project are given in the table below:
Project A123
Project B789
Initial cost (paid immediately)
$500,000
Net cash flow for year 1
$160,000
$225,000
Net cash flow for year 2
$150,000
$205,000
Net cash flow for year 3
$140,000
$120,000
Net cash flow for year 4
$100,000
Assume all cash flows are received at the end of the relevant year. Both projects will have no salvage value after the 4th year.
Star uses a required rate of return 7.5% for the projects.
Required -
(a) Calculate the Payback Periods (PP) for both projects.
(b) Calculate the Net Present Values (NPV) for both projects.
(c) Calculate the Profitability Index (PI) for both projects.
(d) Which of the two projects should be accepted and why?
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