Question

1. You are on a project selection committee and you have been tasked to find the NPV of two potential projects, Project A and Project B. The cash flows and discount rates are as shown below.

Project A
Year	r	Cash Flow
Year 0		-$8,000
Year 1	5%	$5,000
Year 2	5%	$5,000

Project B
Year	r	Cash Flow
Year 0		-$1,000
Year 1	5%	$2,411.90

          

  You find that the NPV of both projects is $1,297.

1. a. Can you make a decision based on the NPVs? Why or why not? (2 points)

2. What is the projected ROI of Project A? (Hint: NPV is considered Net Income right?!) (2 points)

3. What is the projected ROI of Project B? (2 points)

4. Based on ROI which project would you choose and why? (3 points)

Answer 1

a) NPV calculations :

i (rate) = 5% or 0.05, n = no. Of year

Project A

Year	Cash flow	Present value (P V) factor (1/(1+i)^n)	P.V. of cash flow (P.V. factor * Cash flow)
0	(-$8,000)	1	(-$8,000)
1	$5,000	(1/(1+0.05)^1) = 0.9524	$4,762
2	$5,000	(1/(1+0.05)^2) = 0.9070	$4,535
		NPV	$1,297

Project B

Year	Cash flow	P.V. factor (1/(1+i)^n)	P.V. of cash flow (P.V. factor * Cash flow)
0	(-$1,000)	1	(-$1,000)
1	$2,411.90	(1/(1+0.05)^1) = 0.9524	$2,297
		NPV	$1,297

Decision : Based on NPV, decision can not be made. As both projects have same NPV. In this case we can use other methods for the purpose of decision making such as ROI method, Profitability index method or Payback period method.

b) ROI of project A = ( Net income or NPV / Cost of investment) * 100

Here,

NPV (calculated above) = $1,297

Cost of project A (given) = $8,000

Now,

ROI of project A = ($1,297 / $8,000) * 100

ROI of project A = 16.21%

c) ROI of project B = (Net income or NPV / Cost of investment) * 100

Here,

NPV (calculated above) = $1,297

Cost of project B (given) = $1,000

Now,

ROI of project B =( $1,297 / $1,000) * 100

ROI of project B = 129.70%

d) Based on ROI project B is to be choosen. As project B's ROI is much greater than project A.