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    Assignment # 1 Solution Acc501: Years Proposal A Proposal B

    Uploaded by

    Mubeen Raza
    Star Inc is considering two proposals, A and B, for a new leather manufacturing plant. Proposal A has a higher initial investment of $2.5M compared to $2M for Proposal B. Both proposals have negative NPVs. Proposal B has a shorter payback period of 3.47 years compared to 4.04 years for Proposal A. Based on the shorter payback period and lower initial cost, Proposal B is more viable despite both having negative NPVs. IRR is not a good criteria for mutually exclusive projects as it does not consider the investment amount.

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    Assignment # 1 Solution Acc501: Years Proposal A Proposal B

    Uploaded by

    Mubeen Raza
    13 views3 pages
    Star Inc is considering two proposals, A and B, for a new leather manufacturing plant. Proposal A has a higher initial investment of $2.5M compared to $2M for Proposal B. Both proposals have negative NPVs. Proposal B has a shorter payback period of 3.47 years compared to 4.04 years for Proposal A. Based on the shorter payback period and lower initial cost, Proposal B is more viable despite both having negative NPVs. IRR is not a good criteria for mutually exclusive projects as it does not consider the investment amount.

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    ASSIGNMENT#1 ACC501

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    Star Inc is considering two proposals, A and B, for a new leather manufacturing plant. Proposal A has a higher initial investment of $2.5M compared to $2M for Proposal B. Both proposals have negative NPVs. Proposal B has a shorter payback period of 3.47 years compared to 4.04 years for Proposal A. Based on the shorter payback period and lower initial cost, Proposal B is more viable despite both having negative NPVs. IRR is not a good criteria for mutually exclusive projects as it does not consider the investment amount.

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    © All Rights Reserved
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    Download as docx, pdf, or txt
    13 views3 pages

    Assignment # 1 Solution Acc501: Years Proposal A Proposal B

    Uploaded by

    Mubeen Raza
    Star Inc is considering two proposals, A and B, for a new leather manufacturing plant. Proposal A has a higher initial investment of $2.5M compared to $2M for Proposal B. Both proposals have negative NPVs. Proposal B has a shorter payback period of 3.47 years compared to 4.04 years for Proposal A. Based on the shorter payback period and lower initial cost, Proposal B is more viable despite both having negative NPVs. IRR is not a good criteria for mutually exclusive projects as it does not consider the investment amount.

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    © All Rights Reserved
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    Download as docx, pdf, or txt
    of 3

    ASSIGNMENT # 1 SOLUTION ACC501

    Question: Star Inc. is a business concern that is involved in the manufacturing and export of
    leather products. In order to take benefits from the new policies of the government, the company
    is planning to enhance its production capacity by installing a new plant. For this purpose, they
    are considering the two mutually exclusive proposals i.e. Proposal A and Proposal B. The
    estimated initial investments and the associated cash flows of the proposals are listed below:
    Years Proposal A Proposal B
    0 Initial Investment (2,500,000) (2,000,000)
    1 Cash Flows 500,000 500,000
    2 Cash Flows 550,000 550,000
    3 Cash Flows 650,000 600,000
    4 Cash Flows 750,000 750,000
    5 Cash Flows 1250,000 800,000

    For this investment, the benchmark payback period and the required rate of return are set at four
    (4) years and 11% respectively
    a) Calculate Payback Period for each proposal
    Cash Flow Proposal (A)
    Year 1 500,000
    Year 2 550,000
    Year 3 650,000
    Year 4 750,000
    Total 2,450,000

    Remaining= 50,000
    Payback period = Year+ remaining/ next year
    Cash flow = Payback period
    = 4 + 50,000 / 1250,000 = 4.04 years

    Cash Flow Proposal (B)


    Year 1 500,000
    Year 2 550,000
    Year 3 600,000
    Total 1,650,000

    Remaining= 350,000
    Payback period = Year+ remaining/ next year
    Cash flow = Payback period
    = 4 + 350,000 / 750,000 = 3.47 years

    b) Calculate Net Present Value (NPV) for each proposal

     Net Present Value (NPV) for Proposal (A):

    Initial investment = 2,500,000

    ( CF ) CASH FLOW
    As we know formula of NPV = - Initial investment + Y
    1+ r ( rate of return )

    Given the rate of interest is 11%

    Calculation:

    500,000 55 0,000 65 0,000 75 0,000


    NPV = - 2,500,000 + 1 + 2 + 3 +
    ( 1+ 0.11 ) ( 1+ 0.11 ) ( 1+ 0.11 ) ( 1+ 0.11 )4

    NPV = - 2,500,000 + 450,450 + 446,392 + 475,274 + 494,048

    NPV = 1,866,164 – 2,500,000

    NPV = -633,836

    NPV FOR PROPOSAL A IS NEGATIVE

     Net Present Value (NPV) for Proposal (B):

    500,000 550,000 6 0 0,000 750,000


    NPV = - 2,000,000 + 1 + 2 + 3 +
    ( 1+ 0.11 ) ( 1+ 0.11 ) ( 1+ 0.11 ) ( 1+ 0.11 )4

    NPV = - 2,000,000 + 450,450 + 446,392 + 438,715+ 494,048

    NPV = 1,829,605 – 2,000,000

    NPV = -170,395

    NPV FO PROPOSAL B IS NEGATIVE

    c) Based upon payback period and NPV calculated above, suggest which proposal is more
    viable to select?

    Payback Period of Proposal (A)&(B):


    Proposal (A) = 4.04 years & Proposal (B) = 3.47 years

    As we can see, proposal A is significantly more expensive than proposal B, and it’s
    payback period is longer than four years as opposed to proposal B's, which is less than
    four years and will recover quickly before four years.

    Net Present Value:

    Both proposals A and B have negative net present values (NPV), and the investment
    should be approved if the NPV RESULT IN POSITIVE.

    d) Briefly discuss the suitability of IRR criteria while evaluating the mutually exclusive
    projects

    IRR DOES NOT HELP TO MAKE GOOD DECISIONS IN THE CASE OF


    MUTUALLY EXCLUSIVE EVENTS. When a mutually exclusive event occurs, it is
    difficult to make wise decisions. The reason is that it might be positive if we compare
    Proposal A and B based on IRR. We chose Proposal A because it has a large NPV, which
    means it makes more RETURN and has a lower IRR in the event of mutual exclusivity.
    IRR FORGETS THE AMOUNT OF THE INVESTMENT

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