In: Finance
Project 1 | Project 2 | Project 3 | Project 4 | |||
Initial CF | -4,000,000 | -5,000,000 | -10,000,000 | 5,000,000 | ||
Year 1 CF | 1,000,000 | 2,000,000 | 4,000,000 | 2,700,000 | ||
Year 2 CF | 2,000,000 | 3,000,000 | 6,000,000 | 2,700,000 | ||
Year 3 CF |
|
3,000,000 | 5,000,000 |
|
You have a $10 million capital budget and must make the decision about which investments your firm should accept for the coming year. The firm’s cost of capital is 12 percent. Use the information on the four projects to determine what project(s) your firm should accept on the basis of NPV?
Projects 3, 4
Projects 1, 2
Project 3
Projects 2, 4
NPV = Initial cash outlay + PV of all the cash inflows
PV of cash flow at time n = Cash flow at time n/ ((1+r)^n)
NPV = -CF0 + (CF1/((1+Cost of capital)^1)) + (CF2/((1+Cost of capital)^2)) + (CF3/((1+Cost of capital)^3
NPV of Project 1 = -4,000,000+ (1,000,000/((1+12%)^1)) + (2,000,000/((1+12%)^2)) + (3,000,000/((1+12%)^3
= $622,585.64
NPV of Project 2 = -5,000,000+ (4,000,000/((1+12%)^1)) + (3,000,000/((1+12%)^2)) + (3,000,000/((1+12%)^3
= $1,312,636.7
NPV of Project 3 = -10,000,000+ (4,000,000/((1+12%)^1)) + (6,000,000/((1+12%)^2)) + (5,000,000/((1+12%)^3
= $1,913,493.1
NPV of Project 4 = -5,000,000+ (2,700,000/((1+12%)^1)) + (2,700,000/((1+12%)^2)) + (2,700,000/((1+12%)^3
= $1,484,944.42
Project | NPV |
1 | 622,585.64 |
2 | 1,312,636.70 |
3 | 1,913,493.10 |
4 | 1,484,944.42 |
We need to maximize our NPV.
Project 3 & 4 could not be opted because it's not meeting our capital budget of $10 million
Projects 1 and 2's total NPV = $1,935,222.34
Project 3's NPV = $1,913,493.10
Projects 2, 4's total NPV = 2,797,581.12
We will choose Optin D(Projects 2, 4) as in that we are getting the maximum NPV