Question

Bumi Hijau Properties is in the process of deciding to develop an apartment project in Shah Alam. The initial outlay for both projects is RM480,000. The cost of capital is 12%. Below are the expected cash flows from the two projects. Year Suria Apartment Project (RM) Puncak Apartment Project (RM) 1 180,000 165,000 2 210,000 190,000 3 180,000 260,000 4 310,000 345,000 5 278,000 310,000 Required:

a. Based on the above information, you are required to calculate:

i. Payback period for both projects. ( 6 marks)

ii. Net present value (NPV) for both projects.

iii. Profitability index for both projects. ( 4 marks)

b. Which project should be accepted and why? Please state your reason.

Answer 1

Payback Period for Suria Apartment Project

Year	Cash Flows	Cumulative net Cash flow
0	(480,000.00)	(480,000.00)
1	180,000.00	(300,000.00)
2	210,000.00	(90,000.00)
3	180,000.00	90,000.00
4	310,000.00	400,000.00
5	278,000.00	678,000.00

Payback Period = Years before full recover + (Unrecovered cash inflow at start of the year/cash flow during the year)

= 2.00 Years + (90,000 / 180,000)

= 2.00 Years + 0.50 Years

= 2.50 Years

Payback Period for Puncak Apartment Project

Year	Cash Flows	Cumulative net Cash flow
0	(480,000.00)	(480,000.00)
1	165,000.00	(315,000.00)
2	190,000.00	(125,000.00)
3	260,000.00	135,000.00
4	345,000.00	480,000.00
5	310,000.00	790,000.00

Payback Period = Years before full recover + (Unrecovered cash inflow at start of the year/cash flow during the year)

= 2.00 Years + (125,000 / 260,000)

= 2.00 Years + 0.48 Years

= 2.48 Years

Net Present Value (NPV) of Suria Apartment Project

Year	Annual cash flows	Present Value Factor (PVF) at 12.00%	Present Value of annual cash flows [Annual cash flow x PVF]
1	180,000.00	0.89285714	160,714.29
2	210,000.00	0.79719388	167,410.71
3	180,000.00	0.71178025	128,120.44
4	310,000.00	0.63551808	197,010.60
5	278,000.00	0.56742686	157,744.67
TOTAL		811,000.71

Project’s Net Present Value (NPV) = Present value of annual cash inflows – Initial investment costs

= 811,000.71 – 480,000

= 331,000.71

Net Present Value (NPV) of uncak Apartment Project

Year	Annual cash flows	Present Value Factor (PVF) at 12.00%	Present Value of annual cash flows [Annual cash flow x PVF]
1	165,000.00	0.89285714	147,321.43
2	190,000.00	0.79719388	151,466.84
3	260,000.00	0.71178025	185,062.86
4	345,000.00	0.63551808	219,253.74
5	310,000.00	0.56742686	175,902.33
TOTAL		879,007.19

Project’s Net Present Value (NPV) = Present value of annual cash inflows – Initial investment costs

= 879,007.19 - 480,000

= 399,007.19

Profitability Index (PI) for Suria Apartment Project

Profitability Index (PI) = Present value of annual cash inflows / Initial investment costs

= 811,000.71 / 480,000

= 1.45

Profitability Index (PI) for Puncak Apartment Project

Profitability Index (PI) = Present value of annual cash inflows / Initial investment costs

= 879,007.19 / 480,000

= 1.20

DECISION

The Puncak Apartment Project should be accepted, since it has the Higher Net Present Value of 399,007.19.

NOTE    

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.