Financial Management 2 : Assignment 4 Answer

1. What is the payback period of project A?

The correct answer is: 2.8 years or 2 years 10 months

After 2 years, the project has earned $200k leaving $100k to get to payback.The net cash
flow in year 3 is $125 and so 100/125 gives 0.8 of a year or 9.6 months. We can round this
up to 10 months, so overall the project pays back in 2 years and 10 months.

2. What is the payback period of project B?

The correct answer is: 2.67 years or 2 years 8 months

After 2 years, the project has earned $300k leaving $200k to get to payback.The net cash
flow in year 3 is $300 and so 200/300 gives 0.67 of a year or 8 months, so overall the
project pays back in 2 years and 8 months.

3. What is the payback period of project C?

The correct answer is: 3.25 years or 3 years 3 months

After 3 years, the project has earned $375k leaving $75k to get to payback.The net cash flow
in year 4 is $300 and so 75/300 gives 0.25 of a year or 3 months, so overall the project pays
back in 3 years and 3 months.

4. What is the average rate of return (ARR) of project A?

The correct answer is: 13.33%

After 5 years, the project has earned a total cash flow of $500k. The capital cost is $300k and
so the total gain is $200k.If we divide the total gain by 5 (number of years) we get an
average return of $40k.The average annual return of $40k as a percentage of the original
capital cost (40/300 * 100) is 13.33%.

5. What is the average rate of return (ARR) of project B?

The correct answer is: 22%

After 5 years, the project has earned a total cash flow of $1050k. The capital cost is $500k
and so the total gain is $550k.If we divide the total gain by 5 (number of years) we get an
average return of $110k.The average annual return of $110k as a percentage of the original
capital cost (110/500 * 100) is 22%.
 6. What is the average rate of return (ARR) of project C?

The correct answer is: 18.9%

After 5 years, the project has earned a total cash flow of $875k. The capital cost is $450k and
so the total gain is $425k.If we divide the total gain by 5 (number of years) we get an
average return of $85k.The average annual return of $85k as a percentage of the original
capital cost (85/450 * 100) is 18.9%.

7. Which project would you recommend to the board to accept and why?

The best project on these criteria appears to be project B. It has the lowest payback period
(just) of 2 years and 8 months and also has the best ARR figure at 22%.