Question

Giant Equipment Ltd. is considering two projects to invest next year. Both projects have the same start-up costs. Project A will produce annual cash flows of $42,000 at the beginning of each year for eight years. Project B will produce cash flows of $48,000 at the end of each year for seven years. The company requires a 12% return. Required: a) Which project should the company select and why? b) Which project should the company select if the interest rate is 14% at the cash flows in Project B is also at the beginning of each year?

Answer 1

Question a:
Calculation of NPV of the Projects
Year	Project A			Project B
	Cash Flow	Discount Factor@12%	Discounted Cash Flows	Cash Flow	Discount Factor@12%	Discounted Cash Flows
A	B	C = 1/(1+12%)^A	D = B*C	E	F = 1/(1+12%)^A	G = E*F
0	42000	1	42000		1	0
1	42000	0.892857143	37500	48000	0.892857143	42857.14286
2	42000	0.797193878	33482.1429	48000	0.797193878	38265.30612
3	42000	0.711780248	29894.7704	48000	0.711780248	34165.4519
4	42000	0.635518078	26691.7593	48000	0.635518078	30504.86776
5	42000	0.567426856	23831.9279	48000	0.567426856	27236.48907
6	42000	0.506631121	21278.5071	48000	0.506631121	24318.29382
7	42000	0.452349215	18998.667	48000	0.452349215	21712.76234
NPV			233677.775			219060.3139
NPV of Project A is higher than Project B
Hence Project A should be selected
Note:
Cash Flow beginning of Year 1 means cash flow at year 0
Cash Flow beginning of Year 2 means cash flow at year 1
Question b:
Calculation of NPV of the Projects
Year	Project A			Project B
	Cash Flow	Discount Factor@12%	Discounted Cash Flows	Cash Flow	Discount Factor@12%	Discounted Cash Flows
A	B	C = 1/(1+12%)^A	D = B*C	E	F = 1/(1+12%)^A	G = E*F
0	42000	1	42000	48000	1	48000
1	42000	0.892857143	37500	48000	0.892857143	42857.14286
2	42000	0.797193878	33482.1429	48000	0.797193878	38265.30612
3	42000	0.711780248	29894.7704	48000	0.711780248	34165.4519
4	42000	0.635518078	26691.7593	48000	0.635518078	30504.86776
5	42000	0.567426856	23831.9279	48000	0.567426856	27236.48907
6	42000	0.506631121	21278.5071	48000	0.506631121	24318.29382
7	42000	0.452349215	18998.667	0	0.452349215	0
NPV			233677.775			245347.5515
NPV of Project B is higher than Project A
Hence Project B should be selected
Note:
Cash Flow beginning of Year 1 means cash flow at year 0
Cash Flow beginning of Year 2 means cash flow at year 1