December
1998 QUESTION 3 Total Marks: 20 Marks |
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| A company is attempting to choose
which of two three-year projects to develop. The estimated cash flows occuring at the end
of each year of the projects are given below:
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| (a) | Calculate the payback period of both
projects using the payback method. Use your calculation to recommend which of the projects
should be selected using the payback method.
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| (b) | Calculate the net present value of
each project assuming a 10% cost of capital. Use your calculation to recommend which of
the projects should be selected using this assumption and the NPV method.
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| (c) | Calculate the net present value of
each project assuming a 12% cost of capital. Would this higher cost of capital lead you to
make a different recommendation to that made in Part (b)?
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| (d) | Calculate the internal rate of
return estimated from your results in Parts (b) and (c) for both of the projects. Use your
calculation which of the projects should be selected using the IRR method.
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| (e) | Use your answers to Parts (a), (b), (c), and (d) to discuss carefully the relative merits of the three methods i.e. payback, NPV and IRR. | [5] | ||||||||||||||||||