Question

1.

project	initial cost (incurred at beginning of year 1)	Project life	Salvage value	Positive annual cash flow (received at the end of each year)
A	$200000	16 years	$0	$28000
B	$56000	14 years	$0	$9783

B is higher than the Internal Rate of Return of project A.

Required:

A) Is the NPV for Project A higher than, equal to, or lower than, the NPV for Project

B, assuming a 10% discount rate?

B) Is the Payback Period for Project A better than, equal to, or worse than, the

Payback Period for Project B?

C) Is the Accounting Rate of Return for Project A higher than, equal to, or lower

than, the Accounting Rate of Return for Project B, assuming straight-line

depreciation?

D) If the discount rate is 11% instead of 10%, which project has the higher NPV?

E) If the discount rate is 10%, and both projects have a salvage value of $66,000

(i.e., the equipment for Project B actually appreciates), which project would have

the higher NPV?

2.: A merchandising company expects to sell 300 units in April, 400 units in May, and

500 units in June. The company plans to have 30% of each month’s sales, plus an

additional 50 units, on hand in inventory at the beginning of each month. How many

units should the company plan to purchase in May?

Answer 1

A) Statement showing NPV

Particular	Project A	Project B
Annual cash flow	28000	9783
PVIFA(10%,16 years)	7.8237
PVIFA(10%,14 years)		7.3667
Present value of cash inflow	219064	72068
Initial cost	200000	56000
NPV	19064	16068

Thus project A has higher NPV

B) Payback period

Particular	Project A	Project B
Initial cost	200000	56000
Annual cash flow	28000	9783
Payback peiod(initial investment/annual cash flow)	7.14	5.72

Thus payback period of project B is less than that of A

C) Accounting return

Particular	Project A	Project B
Annual cash flow	28000	9783
Less: Depreciation	12500	4000
Profit	15500.00	5783.00
Initial cost	200000	56000
Accounting rate of return(profit/initial cost)	7.75%	10.33%

B has higher accounting rate of return

D) Statement showing NPV where r = 11%

Particular	Project A	Project B
Annual cash flow	28000	9783
PVIFA(11%,16 years)	7.379
PVIFA(11%,14 years)		6.9818
Present value of cash inflow	206615	68303
Initial cost	200000	56000
NPV	6615	12303

Thus project B should be selected

E) Statement showing NPV

Particular	Project A	Project B
Annual cash flow	28000	9783
PVIFA(10%,16 years)	7.8237
PVIFA(10%,14 years)		7.3667
Present value of cash inflow	219064	72068
Add: PV Salvage value
66000*PVIF(10%16th year)	14362
66000*PVIF(10%14th year)		17380
Total cash inflow	233425	89448
Initial cost	200000	56000
NPV	33425	33448

Project B has higher NPV

2) Units to be purchased = (400*70%) - 50

=280-50

230 units