Question

In: Finance

Project Cash Flow Today (millions) Cash Flow in One Year (millions) A -$10 $20 B $6...

Project Cash Flow Today
(millions)
Cash Flow in One Year
(millions)
A -$10 $20
B $6 $4
C $18 -$12

Suppose all cash flows are certain and the​ risk-free interest rate is 5%.

a. What is the NPV of each​ project?

b. If the firm can choose only one of these​ projects, which should it​ choose?

c. If the firm can choose any two of these​ projects, which should it​ choose?

Solutions

Expert Solution

a.

PV factor for year 1, F1 = 1/ (1+r) n

r is rate of interest( 5 %) and no. of year, n is 1

F1 = 1/ (1+5%) = 1/(1+0.05) = 1/1.05 = 0.952380952

NPV of Project A = PV of cash flow in year one - PV of cash flow today

                            = $ 20,000,000 x F1 - $ 10,000,000

                              = $ 20,000,000 x 0.952380952 - $ 10,000,000

                             = $ 19,047,619.05 - $ 10,000,000 = $ 9,047,619.05

NPV of Project B = PV of cash flow in year one + PV of cash flow today

                            = $ 4,000,000 x F1 + $ 6,000,000

                              = $ 4,000,000 x 0.952380952 + $ 6,000,000

                             = $ 3,809,523.81 + $ 6,000,000 = $ 9,809,524

NPV of Project C = PV of cash flow in year one + PV of cash flow today

                            = - $ 12,000,000 x F1 + $ 18,000,000

                              = -$ 12,000,000 x 0.952380952 + $ 18,000,000

                              = $ 18,000,000 - $ 11,428,571.43 = $ 6,571,428.57

[In Project B both cash flows are positive where as in Project C cash flow in year 1 is negative]

b.

The firm can choose Project B, as its NPV is highest.

c.

The firm can choose Project B and Project A as their NPVs are higher than Project C.


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