Dorian International has $75,000 that it can invest for 2.5 years.After that,the funds are needed to repay an outstanding bond issue.The company has two potential projects that are within the funding limit.Project A has an initial cost of $40,000 and cash flows of $24,000 a year for 2 years.Project B has an initial cost of $75,000 and cash flows of $27,000 a year for 4 years.If the required rate of return on both projects is 12 percent,what is your recommendation?
A)Accept Project A and reject Project B
B)Reject Project A and accept Project B
C)Accept either Project A or Project B,but not both
D)Reject both projects
E)Accept both projects

Question

Quizplus · Accepted Answer

Because the company must have the funds returned within 2.5 years,any project that can be accepted must pay back within 2.5 years and also have a positive NPV. Payback_A = 1 + ($40,000 - $24,000)/ $24,000 = 1.67 years;Project A meets the payback requirement. Payback_B = 2 + ($75,000 - $27,000 - $27,000)/ $27,000 = 2.78 years;Project B must be rejected because it does not meet the mandatory payback period of 2.5 years. NPV_A = -$40,000 + $24,000 / 1.12 + $24,000 / 1.12 = $561.22;Project A passes the NPV test. Since Project A passes both the payback and the NPV tests,it should be accepted.Project B must be rejected because the company must recoup its investment in 2.5 years,and Project B will not do that.

Dorian International Has $75,000 That It Can Invest for 2