Financial Policy

FIN-52010-32
John J. Loughlin, PhD
Week 5
Spring-1, 2020
Harmon Hall #254
636-949-4159
jloughlin@lindenwood.edu
METHODS OF FINANCIAL EVALUATION
• Payback
• Discounted Payback
• Internal Rate of Return (IRR)
• Net Present Value (NPV)
• Profitability Index (PI)
Payback

Cost Returns
Year 1 Year 2 Year 3 Year 4 Year 5
-10000 2,500 3,000 3,500 4,000 4,500
-10000 -7,500 -4,500 -1,000
-7,500 -4,500 -1,000

0.25
3.25 years
Discounted Payback

Cost Returns 4% Discount

Year 1 Year 2 Year 3 Year 4 Year 5
-10000 2,500 3,000 3,500 4,000 4,500

2,404 2,774 3,111 3,419 3,699

-10000 -7,596 -4,822 -1.711
-7,596 -4,822 -1.711
0.5
3.50 years
Mutually Exclusive Problem
You are evaluating two mutually exclusive projects. Project “A” requires a cost of $15,200 and project “B” requires a
cost of $13,900. Your cost of capital is 9%. The cash flows are as follows:
“A” “B”
Year 1 4,000 3,000
2 4,000 4,000
3 4,000 5,000
4 4,000 6,000
5 4,000 Ends at 4 years
Ends at 5 years

Which project would you choose if they are mutually exclusive? Show the NPV, IRR and Equivalent Annuity for each
and tell which test determines the best choice.
 
Project “A” Project “B”

IRR ________ ________

NPV ________ ________
EA ________ ________
Mutually Exclusive Projects
You are evaluating two projects. Project “A” requires a cost of $16,000 and project “B” requires a cost of $23,000. Your cost
of capital is 11%. The cash flows are as follows:
“A” “B”
Year 14,200 5,100
24,200 5,100
34,200 5,100
44,200 6,100
54,200 6,100
6 Ends in 5 years 6,100
Ends in 6 years
Which project would you chose if they are mutually exclusive? Show the
NPV, IRR and Equivalent Annuity for each and tell which test determines the winner.

Project “A” Project “B”

IRR
NPV
EA