12 a Payback period is the time in which the whole project cost is recovered.
Project A = 100000/32000 = 3.125 year
Project B = 4.5 years
In case of project B for first 4 years there is no cash flow and hence no recovery but in fifth year there is a cash inflow of 200000. It is assumed that this 200000 occurs proportionately for the whole year and hence 100000 is recovered by year end. 100000/200000 = .5 years. Thus the payback period for this project becomes 4 years + .5 year = 4.5 years.
b NPV
5
Project A = -100000 + ∑ 32000 (1.15) pwr t = $18268
T=0
Project B = -100000 + 200000(1.15) pwr 5 = -$564
c IRR
5
Project A 0 = -100000 + ∑ 32000 (1+r) pwr t
T=0
R = 18.03%
Project B 0 = -100000 + 200000(1+r) pwr 5
R = 14.87%
d Although the initial cost of project A and B is same and the total cash flow for project A (32000*5 = 160000) is less than the cash flow for project B (200000) ranking conflict is caused because Project A generates the cash flow consistently throughout the project life whereas Project B generates it only at the end of project life and hence project A has the higher ranking. Since the project A has cash flow very early in project life the discount rate applied to its cash inflow are less than that applied to project B which has all the cash flow concentrated in last year. For e.g. the initial cash flow of Project A had present value of just 32000/(1.15) whereas the initial cash flow of B had present value of 200000/(1.15)5. In short discounting creates all the difference.
e Project A should be accepted because it has positive NPV and higher IRR.