Multiple choice

THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 1 AND 2. 

Consider the following two mutually exclusive projects, each of which requires an initial investment of $30,000 and both provide cash inflows of $60,000 as shown below. This organization has a 15% cost of capital. 

Year     Project A     Project B 

0     ($30,000)      ($30,000) 

1     $30,000     $10,000 

2     20,000     20,000 

3      10,000     30,000 

1. Using the payback criterion, which is the most desirable project? 

Project A 

Project B 

Both projects A and B are equally acceptable. 

Neither project A or B is acceptable. 

2. Using the net present value criterion, which is the most desirable project? 

Project A 

Project B 

Both projects A and B are equally acceptable. 

The desirability cannot be determined using the current information. 

The following Information applies to questions 1 and 2. 

Sollberger Company is now investigating three mutually exclusive investment opportunities. The company’s cost of capital is 10 percent. Information on the three investment projects under study is given below: 

     1     2     3 

Initial investment     $(40,000)     $(36,000)     $(45,000) 

Net present value     $(2,024)     $7,340     $7,297 

Profitability index     0.95     1.20     1.10 

Internal rate of return     8%     14%     19% 

Life of the project     5 yrs     12 yrs     3 yrs 

Sollberger Company has limited funds available for investment and, therefore, it can’t accept all of the projects listed above. 

3. Which projects are acceptable to Sollberger? 

investment 2 

investment 3 

investment 2 and 3 

investment 1, 2, and 3 

4. Which single investment do you recommend of these three mutually exclusive projects? 

investment 1 

investment 2 

investment 3 

All of these investments could be recommended.