Question

1. Consider project S and L, and their projected cashflows. Both projects are equally risky. (Assume cost of capital is 10%)

	Expected after-tax cash flows	Expected after-tax cash flows
Year(t)	Project S	Project L
0(today)	($1,000)	($1,000)
1	500	100
2	400	300
3	300	400
4	100	600

Required;

1. Find the NPV of each of the projects.
2. Calculate the B/C ratio
3. In each case state if we should accept the project or not and explain your answer.

Answer 1

Q1) NPV of project S = - cash outflow + cash inflow/ (1+r)^n

= -1,000 + 500/(1+0.10)^1 + 400/(1+0.10)^2 + 300/(1+0.10)^3 + 100/(1+0.10)^4

= -1,000 + 500/1.10 + 400/1.21 + 300/1.331 + 100/1.4641

= -1,000 + 454.5455 + 330.5785 + 225.3944 + 68.30

= -1,000 + 1,078.82

=$78.82

NPV of project L = - cash outflow + cash inflow/ (1+r)^n

= -1,000 + 100/(1+0.10)^1 + 300/(1+0.10)^2 + 400/(1+0.10)^3 + 600/(1+0.10)^4

= -1,000 + 100/1.10 + 300/1.21 + 400/1.331 + 600/1.4641

= -1,000 + 90.9091 + 247.9339 + 300.5259 + 409.8081

= -1,000 + 1,049.18

=$49.18

Q2) Benefit cost ratio of Project S= Present value of expected benefit / present value of cost

= 1,078.82 / 1,000

= 1.079

Benefit cost ratio of Project L= Present value of expected benefit / present value of cost

= 1,049.18 / 1,000

= 1.049

Q3) In both the cases, we should accept the project. This is because both the projects have positive NPV and positive benefit to cost ratio.