Question

Dunning, Inc. is trying to decide between two investment projects using NPV. Project A requires an initial investment of $600,000 and has annual cash inflows of $196,000 for the next 5 years. Project B has an initial investment of $400,000 and offers annual cash inflows of $88,000 over the next 7 years. Dunning, Inc. uses a 6% discount rate to evaluate investment projects.

a) Calculate the NPV for both projects and determine which investment Dunning should choose.

Answer 1

Solution:-

PROJECT - A NPV CALCULATION

Year	Discounting factor (please refer to the below note) (A)	Cash Inflow (B)	Present value of cash inflow     A X B
1	.943	$196,000	$184,828
2	.890	$196,000	$174,440
3	.840	$196,000	$164,640
4	.792	$196,000	$155,232
5	.747	$196,000	$146,412
PRESENT VALUE OF TOTAL CASH INFLOW			$825,552
INITIAL INVESMENT			$600,000
Net present value (PRESENT VALUE OF TOTAL CASH INFLOW - INITIAL INVESMENT)			$225,552

PROJECT - B NPV CALCULATION

Year	Discounting factor (please refer to the below note) (A)	Cash Inflow (B)	Present value of cash inflow      A X B
1	.943	$88,000	$82,984
2	.890	$88,000	$78,320
3	.840	$88,000	$73,920
4	.792	$88,000	$69,696
5	.747	$88,000	$65,736
6	.705	$88,000	$62,040
7	.665	$88,000	$58,520
PRESENT VALUE OF TOTAL CASH INFLOW			$491,216
INITIAL INVESMENT			$400,000
Net present value (PRESENT VALUE OF TOTAL CASH INFLOW - INITIAL INVESMENT)			$91,216

CONCLUSION NPV OF PROJECT A = $225,552 NPV OF PROJECT B = $91,216 NPV of PROJECT A is greater than PROJECT B From the above conclusion we can say that Dunning should choose PROJECT A as its NPV is greater than PROJECT B

Note - Calculation of discounting factor

Year	Discounting factor 1 / [ (1 + r)^n ]
1	1 / [(1 +0.06) ^1]	.943
2	1 / [(1 +0.06) ^2]	.890
3	1 / [(1 +0.06) ^3]	.840
4	1 / [(1 +0.06) ^4]	.792
5	1 / [(1 +0.06) ^5]	.747
6	1 / [(1 +0.06) ^6]	.705
7	1 / [(1 +0.06) ^7]	.665

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