Solution
Neenisha answered on
Aug 13 2021
Principles of Finance
We have two projects – Option A – Repair the Machine and Option B – Buy a New Machine. The cash flow from both the projects for next 5 years are shown as follows.
OPTION A: REPAIR THE MACHINE
0
1
2
3
4
5
(50,000)
31,500
20,100
18,900
17,100
13,700
OPTION B: BUY A NEW MACHINE
0
1
2
3
4
5
(4,00,000)
91,300
1,55,000
1,27,800
1,26,900
1,25,100
Internal Rate of Return and Profitability Index
For both the option we have computed Internal Rate of Return (IRR) and Profitability Index (PI). The IRR of Option A is 35.32% which is higher than the Option B. Also, the profitability for Option A i.e. repairing the machine is higher as the initial investment is less and cash flows are still decent.
Option A
Option B
Internal Rate of Return (IRR)
35.32%
16.56%
Profitability Index (PI)
52.48%
11.92%
Three Scenarios – NPV and Payback period Calculation
Case 1
WACC
12%
Option A
Option B
Net Present Value (NPV)
26,242.35
47,680.77
Payback Period (PB) (Discounted) - Option A
0
1
2
3
4
5
Cash Flows
(50,000)
31,500
20,100
18,900
17,100
13,700
Discounted Cash Flows
(50,000)
28,125
16,024
13,453
10,867
7,774
Cumulative Cash Flows
(50,000)
(21,875)
(5,851)
7,601
Payback Period
2.43
Payback Period (PB) (Discounted) - Option B
0
1
2
3
4
5
(4,00,000)
91,300
1,55,000
1,27,800
1,26,900
1,25,100
Discounted Cash Flows
...