THE DILEMMA AT DAY-PRO

1. Calculate the Payback Period of each project. Explain what argument Tim should make
to show that the Payback Period is not appropriate in this case.

Payback Synthetic Resin

Year
1 350,000 -650,000
2 400,000 -250,000
3 500,000 250,000
4 650,000
5 700,000

PBP – 2 = 0 – (-250,000)
3–2 250,000 – (-250,000)

PBP – 2 = 250,000
1 500,000
= 2.5 years #

Payback Epoxy Resin

Year
1 600,000 -200,000
2 400,000 200,000
3 300,000
4 200,000
5 200,000

PBP – 1 = 0 – (-200,000)
2–1 200,000 – (-200,000)
 PBP – 1 = 200,000
1 400,000
= 1.5 years #

Payback period is the length of time required for an investment to recover its initial outlays in
terms of profits or savings. The lesser the time taken is the better. So in this project is better to
choose the Epoxy Resin compare to Synthetic Resin since the Payback Period for Epoxy Resin is
1.5 years while the Synthetic Resin is 2.5 years.

2. Calculate the Discount Payback Period (DPP) using 10% as the discount rate. Should
Tim ask the Board to use DPP as the deciding factor? Explain.

Payback Synthetic Resin

Year
0 -1,000,000 -1,000,000 -1,000,000
1 350,000 318,185 -681,815
2 400,000 330,560 -351,255
3 500,000 375,650 24,395
4 650,000
5 700,000

Discounted Payback
2 + 351,255
375,650

= 2.94 years #
 Payback Epoxy Resin
Year
0 -800,000 -800,000 -800,000
1 600,000 545,460 -254,540
2 400,000 330,560 76,020
3 300,000
4 200,000
5 200,000

Discounted Payback
1 + 254,540
330,560

= 1.77 years #

Discounted Payback period is the amount of time that its take for the initial cost of a project to
equal to discounted value of expected cash flows, or the time it takes to break even from an
investment. It is the period in which the cumulative NPV of a project equals zero. The lesser the
amount of time taken is the better. So in this project is better to choose the Epoxy Resin compare
to Synthetic Resin since the Payback Period for Epoxy Resin is 1.77 years while the Synthetic
Resin is 2.94 years.

3. If management prefers to have 40% accounting rate of return, which project would be
accepted? What is wrong with this decision?

Synthetic Resin
Net income: 150,000 + 200,000 + 300,000 + 450,000 + 500,000 = 1,600,000

Average profit: 1,600,000 = 320,000 / year

5 years
Average investment: 1,000,000 = 500,000
2

Accounting Rate of Return: 320,000 x 100% = 64%

500,000

Epoxy Resin
Net income: 440,000 + 240,000 + 140,000 + 40,000 + 40,000 = 900,000

Average profit: 900,000 = 180,000 / year

5 years

Average investment: 800,000 = 400,000

2

Accounting Rate of Return: 180,000 x 100% = 45%

400,000

Accounting Rate of Return is built to evaluate profit and it can be easily manipulate with changes
in depreciation method. It disregards the time factor in term of time value of money or risk for
long term investment. Since the management prefers to have a 40% accounting rate of return,
both project is exceed more than 40% so both will be generate profit but there will be more profit
generate if Synthetic Resin project being choose.

4. Calculate the two projects’ IRR. How should Tim convince the Board that the IRR
measure could be misleading?

Synthetic Resin
Year Cash Flow PVIF,40%,n PVIF,10%,n
0 -1,000,000 1 1 -1,000,000 -1,000,000
1 350,000 0.7143 0.9091 250,000 318,185
 2 400,000 0.5102 0.8264 204,080 330,560
3 500,000 0.3644 0.7513 182,200 375,650
4 650,000 0.2603 0.6830 169,195 443,950
5 700,000 0.1859 0.6209 130,130 434,630
935,605 1,902,975
-1,000,000 -1,000,000
-64,395 902,975

10% IRR 40%

902,975 0 -64,395

IRR – 10% = 0 - 902,975

40% - 10% -64,395 – (902,975)

IRR – 10% = - 902,975

30% - 967,370

IRR – 10% = 0.9334 x 30%

IRR = 28% + 10%

IRR = 38%

Epoxy Resin
Year Cash Flow PVIF,40%,n PVIF,45%,n
0 -800,000 1 1 -800,000 -800,000
1 600,000 0.7143 0.6897 428,580 413,820
2 400,000 0.5102 0.4756 204,080 190,240
3 300,000 0.3644 0.3280 109,320 98,400
4 200,000 0.2603 0.2262 52,060 45,240
5 200,000 0.1859 0.1560 37,180 31,200
 831,220 778,900
-800,000 -800,000
31,220 -21,100

40% IRR 45%

31,220 0 -21,100

IRR – 40% = 0 - 31,220

45% - 40% -21,100 – 31,220

IRR – 40% = - 31,220

5% - 52,320

IRR – 40% = 0.5967 x 5%

IRR = 2.984% + 40%

IRR = 42.98%

The Epoxy internal rate return is greater compare to Synthetic, therefore Epoxy Project should be
chosen in this project. This is because internal rate return is a measure of an investment’s rate of
return. The term internal refers to the fact that the internal rate exclude external factors.

5. Calculate the NPV profiles for the two projects and explain the relevance of the crossover
point. How should Tim convince the Board that the NPV method is the way to go?

Synthetic Resin
Year Cash Flow PVIF,38%,n
0 -1,000,000 1 -1,000,000
1 350,000 0.7246 253,610
2 400,000 0.5251 210,040
3 500,000 0.3805 190,250
 4 650,000 0.2757 179,205
5 700,000 0.1998 139,860
972,965
-1,000,000
-27,035

Epoxy Resin

Year Cash Flow PVIF,42.98%,n

0 -800,000 1 -800,000
1 600,000 0.6994 419,640
2 400,000 0.4892 195,680
3 300,000 0.3421 102,630
4 250,000 0.2393 47,860
5 200,000 0.1673 33,460
799,270
-800,000
-730
NPV should be 0, however in this case Synthetic Resin NPV is -27,035 while Epoxy Resin NPV
is -730, the company should choose Epoxy Resin compare to Synthetic Resin since Epoxy is
greater than -27,035