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Farmer Co. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the shorter payback, some value may be forgone. How much value will be lost in this instance? Note that under some conditions choosing projects on the basis of the shorter payback will not cause value to be lost.r = 10.25%Year 0 1 2 3 4CFS −$950 $500 $800 $0 $0CFL −$2,100 $400 $800 $800 $1,000a. $24.14b. $26.82c. $29.80d. $33.11e. $36.42

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facundobuzzetti

Answer:

The correct answer is D.

Explanation:

Giving the following information:

i= 0.1025

NPV= -Io + ∑[Cf/(1+i)^n]

Cf= cash flow

Project 1:

Year 0 1 2 3 4 CFS:

−$950 $500 $800 $0 $0

Year 1= 500 - 950= -450

Year 2= 800 - 450= 350

Payback period= 1 year + (450/800)= 1.56 years

NPV=161.68

Project 2:

Year 0 1 2 3 4 5:

−$2,100 $400 $800 $800 $1,000

Year 1= 400 - 2,100= -1,700

Year 2= 800 - 1,700= -900

Year 3= 800 - 900= -100

Year 4= 1000 - 100= 900

Payback period= 3 years + (100/1000)= 3.1 years

NPV= 194.79

Value lost= 194.79 - 161.68= $33.11

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