Question

The following information was provided for two mutual exclusive investment opportunities, only one of which may be selected.

	Project A	Project B
Initial Investment(CF0)	100 000	90 000
Year(t)	Profit for the year
1	50 000	35 000
2	40 000	35 000
3	30 000	33 000
4	30 000	70 000
Resale cash value Year 4	20 000	30 000

Notes

o Profit is calculated after deducting straight line depreciation.

o The cost of capital is 18% per annum.

a) Calculate annual depreciation amount for each project.

b) Compute cash flow from operation for each project.

c) Estimate net present value for each project.

d) Based on analysis above, which project would you recommend for the firm.

Answer 1

a)Annual Depreciation for each project :

Particulars	Project A ($)	Project B ($)
Cost of Asset	100,000	90,000
Less:Salvage value at the end of 4th year	(20,000)	(30,000)
Depreciable Amount	80,000	60,000
÷ Useful Life	÷4	÷4
Annual Depreciation	20,000	15,000

b) Cash flow from operations for each project

A. Project A

Year	Profit after Depreciation (A)	Depreciation (B)	Cash flows from operations(C=A+B)
1	$50,000	20,000	$70,000
2	$40,000	20,000	$60,000
3	$30,000	20,000	$50,000
4	$30,000	20,000	$50,000

B. Project B

Year	Profit after Depreciation (A)	Depreciation(B)	Cash flows from operations (C=A+B)
1	$35,000	$15,000	$50,000
2	$35,000	$15,000	$50,000
3	$33,000	$15,000	$48,000
4	$70,000	$15,000	$85,000

c.Expexted Net present Value for each project

A. project A

1. Present Value of Cash Outflows (P.V.C.O.)

Initial investment at Day 1=$100,000

2.Present Value of Cash inflows (P.V.C.I.)

Year End	Cash flows($) (operating /Terminal)	Disc. factor @18%p.a.	Present Value ($)
1	70,000	0.8475	59,325
2	60,000	0.7182	43,092
3	50,000	0.6086	30,430
4	70,000 (50,000+20,000)	0.5158	36,106
Total			168,953

3.Net Present Value =P.V.CI.- P.V.C.O

=$168,953-$100,000

=$68,953

expected N.P.V. for Project A =$68,953

B.Project B

1.Present Value of Cash Outflows P.V.C.O

Initial investment at Day 1=$90,000

2.Present Value of Cash inflows P.V.CI

Year end	Cash Flows ($) (Operating/Terminal)	Disc. factor @18%p.a.	Present Value ($)
1	50,000	0.8475	42,375
2	50,000	0.7182	35,910
3	48,000	0.6086	29,213
4	115,000 (85,000+30,000)	0.5158	59,317
Total			166,815

3. Net Present Value =P.V.CI.-P.V.C.O

=$166,815-$90,000

=$76,815

Expected NPV for Project B =$76,815

d. Based on expected N.P.V. calculated in point C we should recommend to the firm for accepting the project B as it's N.P.V. is higher by amount of $ 7,862($76,815-$68,953)