Question

Mr tan is considering 2 potential investment projects that have similar capital requirements:

	Year 0	year 1	year 2	year 3	year 4
project A	4,000,000	1,600,000	1,800,000	2,000,000	2,100,000
Project B	4,200,000	500,000	1,700,000	1,900,000	2,000,000

For project A,the company cost of capital is 14%.For project B,assessed as the riskier project of the two.,a risk adjusted cost of capital of 15% is considered appropriate.

1) calculate the NPV of the 2 projects and assess the projects using the investment appraisal technique of Net present Vale.

2)Calculate the IRR of the 2 projects and assess the projects using the investment appraisal technique of Internal rate of return.

3) Is the company cost of capital suitable in the evaluation of projects with different risks? Explain

Answer 1

						1	2
	Year 0	year 1	year 2	year 3	year 4	NPV	IRR
project A	-4000000.00	1600000.00	1800000.00	2000000.00	2100000.00	1381861.94	29.17%
Project B	-4200000.00	500000.00	1700000.00	1900000.00	2000000.00	-86985.82	14.13%

1: Select Project A since it has higher NPV

2: Select Project A since it has higher IRR.

3: Cost of capital differs given the different risks involved. Higher the risk, higher is the cost involved and lower the returns.

WORKINGS