Question

Mathemitcs of finance

following learning outcomes:

• Time value for money and the rate of return
• Assess the simple interest and compound interest
• Net Present value in Capital Budgeting (Internal rate of return, Payback period)

Clearly identifying all steps, results, and including comments besides each answer.

1. You can invest in to projects:

PROJECT A

A five-year scope project that consists on an initial investment of 110,000€ and a set of 5 yearly revenues of 25.000€ from year 1 to year 5

PROJECT B

A six-year scope project that consists on an initial investment of 100,000€ and a set of 6 yearly revenues of 21.000€ from year 1 to year 6.

a) If the cost of capital is 6%, which one would you choose and why? (15 points)

b) if you only want your money back as soon as is possible. What is the best option? (10 points)

Answer 1

A) Using financial calculator to calculate Npv of project A

Step 1: Press CF

Inputs: C0= -110,000

C1= 25,000. Frequency=5

Step2: Press CF

I = 6%

Npv= compute

We get, Npv of the project A as -$4,690.91

Using financial calculator to calculate the Npv of the project B

Step1: press CF

Inputs: C0= -100,000

C1= 21,000. Frequency= 5

Step2: Press NPV

I= 6%

Npv= compute

We get, NPV of the project as $3,263.81

As the NPV of the Project B is higher than that of project A , we will choose Project B.

Using financial calculator to calculate IRR of project A

Step 1: Press CF

Inputs: C0= -110,000

C1= 25,000. Frequency= 5

Step 2 : Press IRR

IRR= compute

We get, IRR of the project A as 4.418%

Using financial calculator to calculate the IRR of project B

Step 1: Press CF

Inputs: CF0= -100,000

CF1= 21,000. Frequency= 6

Step 2 : Press IRR

Irr= compute

We get, IRR of the project B as 7.032%

As the IRR of project B is higher than Project A , we should choose Project B.

B)

Payback period is calculated on the basis of how fast the money is recovered.

Payback period of Project A

Payback period= year before payback period occurs + amount left to be recovered / amount of last year of recovery

= 4 + 10,000/25000

= 4 + 0.4

= 4.4 years

Payback period of Project B

Payback period= year before payback occurs + amount left to be recovered / amount of last year of recovery

= 4 +16,000/21,000

= 4 + 0.76

= 4.76 years

The best option is Project A because it has lower payback period, so the money will be recovered faster.