Question

Corporate Finance

1. ABC Pvt. Ltd. is considering two mutually exclusive capital investments. The project’s expected net cash flows are as follows:

Expected Cash Flows
Year	Project A	Project B
0	-375	-575
1	-300	190
2	-200	190
3	-100	190
4	600	190
5	600	190
6	926	190
7	-200	0

If you were told that each project’s cost of capital was 12%, which project should be selected using the NPV criteria? What is each project’s IRR? What is the regular payback period for these two projects? What is the profitability index for each project if the cost of capital is 12%? The answer should be a min of 800 words in Computerized word format

Answer 1

Net present value of project (A)

Years	Cash flows $	PVIF@12%	PV ($)
0	- 375	1.0000	-375.00
1	-300	0.8929	-267.87
2	-200	0.7972	-159.44
3	-100	0.7118	-71.18
4	600	0.6355	381.30
5	600	0.5674	340.44
6	926	0.5066	469.11
7	-200	0.4523	-90 46
NPV (Sum up)			$226.90

Net present value of project (B)

NPV = - initial cost + ACF(PVIF12%,6)

NPV = -575 + 190(PVIF12%,6)

NPV = - 575 + 190*4.1114

NPV = $206.17

Based on NPV Creterian Project (A) should be selected , because of its higher NPV

Calculation of IRR of both the projects , using Excel function of IRR would be as follows

Regular payback periods

Project A = 4 years + 375/600 = 4.625 years

Project B = 575/190 = 3.03 years

Profitability index (PI)

PI = PV cash inflow/initial costs

PI (A) = 601.90/375 = 1.6051

PI (B) = 781.17/575 = 1.3586