Question

03) (30 pts) Suppose a company must choose between two projects (A and B) with the following characteristics: Project A Project B Cost of equipment (investment) $770,000 0 Working capital (investment) 0 $710,000 Cash flow (year 2) $200,000 $250,000 Cash flow (year 3) $270,000 $250,000 Cash flow (year 4) $270,000 $250,000 Cash flow (year 5) $300,000 $250,000 Assume an effective rate of 6% per year. Calculate the NPV for each alternative. Which project should the company choose and why?

Answer 1

	Project A	Project B
Year	Cost of Equipment	Cash Inflow	Net Cash flow	PVF @ 6%	PV	Working Capital	Cash Inflow	Net Cash flow	PVF @ 6%	PV
N	A	B	C=A+B	D=1/1.06^N	E=C*D	F	G	H=F+G	D	I=H*D
-	-7,70,000		-7,70,000	1.000	-7,70,000	-7,10,000		-7,10,000	1.000	-7,10,000
1			-	0.943	-			-	0.943	-
2		2,00,000	2,00,000	0.890	1,77,999		2,50,000	2,50,000	0.890	2,22,499
3		2,70,000	2,70,000	0.840	2,26,697		2,50,000	2,50,000	0.840	2,09,905
4		2,70,000	2,70,000	0.792	2,13,865		2,50,000	2,50,000	0.792	1,98,023
5		3,00,000	3,00,000	0.747	2,24,177		2,50,000	2,50,000	0.747	1,86,815
				NPV (Sum of E)	72,739				NPV (Sum of I)	1,07,242

As NPV of Project B is higher it should be accepted.

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