Question

A company has the opportunity to do any, none, or all of the projects for which the net cash flows per year are shown below. The company has a cost of capital of 14%. Which should the company do and why? You must use at least two capital budgeting methods. Show your work.

Year	A	B	C
0	-300	-150	-350
1	100	50	100
2	100	100	100
3	100	100	100
4	100	100	100
5	100	100	100
6	50	100	100
7	100	200	0

Answer 1

Here , We can use Net Present Value and Profitability Index Capital Budgeting Techniques to Evaluate the Projects

On the results of the above capital budgeting techniques, The Company has to do with Project B, Since it has a high Net Present Value of $ 274.95 as compared to Project A [$106.06] and Project C [$38.88].

Net Present Value [NPV] Method

Project - A

Year	Cash Inflow	Present Value Factor at 14%	Present Value of cash flow
1	100	0.877192982	87.72
2	100	0.769467528	76.95
3	100	0.674971516	67.50
4	100	0.592080277	59.21
5	100	0.519368664	51.94
6	50	0.455586548	22.78
7	100	0.399637323	39.96
			$ 406.06

Net Present Value = Present Value of cash inflows – Initial Investments

= $ 406.06 – 300

= $106.06

Project - B

Year	Cash Inflow	Present Value Factor at 14%	Present Value of cash flow
1	50	0.877192982	43.86
2	100	0.769467528	76.95
3	100	0.674971516	67.50
4	100	0.592080277	59.21
5	100	0.519368664	51.94
6	100	0.455586548	45.56
7	200	0.399637323	79.93
			$424.95

Net Present Value = Present Value of cash inflows – Initial Investments

= $424.95 - 150

= $274.95

Project - C

Year	Cash Inflow	Present Value Factor at 14%	Present Value of cash flow
1	100	0.877192982	87.72
2	100	0.769467528	76.95
3	100	0.674971516	67.50
4	100	0.592080277	59.21
5	100	0.519368664	51.94
6	100	0.455586548	45.56
7	0	0.399637323	-
			$ 388.88

Net Present Value = Present Value of cash inflows – Initial Investments

= $ 388.88 – 350

= $38.88

Profitability Index Method

Profitability Index = Value of cash inflows / Initial Investments

Project A = $ 406.06 / 300 = 1.35

Project B = $424.95 / 150 = 2.83

Project C = $ 388.88/ 350 = 1.11

As per Profitability Index Method, Project B is acceptable, It means that for every $1 of cash flow, it will give the $2.83 of Net Present Value