Question

Smith Machining Corp. is a small business considering investing in one of 2 new product production lines. However, they can only afford to do one of the projects. The development and implementation of either project will take a year and the initial cash outlay will be $1,500,000 if they take a traditional bank loan at 10%. If they pursue a Small Business Association (SBA) guaranteed loan through their bank, the rate on the loan will be 7% however, they will need to pay an up-front fee of 10% of the net proceeds of their loan, which can be added to the loan. The projects have the following projected net cash flows:

Year	Project A	Project B
1	$         250,000	$         100,000
2	$         250,000	$         100,000
3	$         250,000	$         100,000
4	$         500,000	$         100,000
5	$         500,000	$         100,000
6	$         250,000	$         400,000
7	$         100,000	$         750,000
8	$            50,000	$         750,000
9	$            50,000	$      1,000,000

1. Calculate and show the NPV of each project at the 10% rate
2. Calculate and show the NPV of each project at the 7% SBA loan rate
3. Which project would you choose, A or B and why?
4. Does the SBA loan improve the result and would you recommend getting the SBA loan even with the added 10% cost? Why or why not?

Answer 1

A) Rate = 10%

Year	Present Value Factor {1/((1+0.1)^year)}	Project A Amount ($)	Present Value ($) Amount * Present Value factor	Project B Amount ($)	Present Value ($) Amount * Present Value factor
0	1.00	(1,500,000)	(1,500,000.00)	(1,500,000)	(1,500,000.00)
1	0.91	250,000	227,272.73	100,000	90,909.09
2	0.83	250,000	206,611.57	100,000	82,644.63
3	0.75	250,000	187,828.70	100,000	75,131.48
4	0.68	500,000	341,506.73	100,000	68,301.35
5	0.62	500,000	310,460.66	100,000	62,092.13
6	0.56	250,000	141,118.48	400,000	225,789.57
7	0.51	100,000	51,315.81	750,000	384,868.59
8	0.47	50,000	23,325.37	750,000	349,880.54
9	0.42	50,000	21,204.88	1,000,000	424,097.62
NPV	10,644.93		263,714.99

B) Rate = 7%

Year	Present Value Factor {1/((1+0.07)^year)}	Project A Amount ($)	Present Value ($) Amount * Present Value factor	Project B Amount ($)	Present Value ($) Amount * Present Value factor
0	1.00	(1,350,000)	(1,350,000.00)	(1,350,000)	(1,350,000.00)
1	0.93	250,000	233,644.86	100,000	93,457.94
2	0.87	250,000	218,359.68	100,000	87,343.87
3	0.82	250,000	204,074.47	100,000	81,629.79
4	0.76	500,000	381,447.61	100,000	76,289.52
5	0.71	500,000	356,493.09	100,000	71,298.62
6	0.67	250,000	166,585.56	400,000	266,536.89
7	0.62	100,000	62,274.97	750,000	467,062.31
8	0.58	50,000	29,100.46	750,000	436,506.83
9	0.54	50,000	27,196.69	1,000,000	543,933.74
NPV	329,177.38		774,059.51

C) From both the cases it is evident that project B is more profitable than A.

D) SBA loan improves result of the NPA. Hence, it is recommended to take the SBA loan.