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In: Finance

1. A company has three new project ideas that are all expected to last 4 years....

1. A company has three new project ideas that are all expected to last 4 years. Unfortunately due to a resource constraint they can only pursue 2 of these projects. Assume the development costs for all projects are paid up front (i.e. prior to the start of the project). The specific financial projections for the three projects are:
·         Project 1 – Development cost would be $50,000. Projected revenues from the project are $50,000 in the first year with an expected annual growth of 10% each of the next 3 years.
·         Project 2 - Development cost would be $100,000. Projected revenues from the project are expected to be a constant $72,000 for all 4 years.
·         Product 3 - Development cost would be $150,000. Projected revenues are $100,000 in the first year with an expected decline of 10% each of the next 3 years.
If the company uses a 7.5% hurdle rate and estimates inflation at 1% annually what is each project’ s NPV? (In addition to the total NPV for each project You MUST show your calculations & annual NPV values for each project)
Project 1
YEAR NetFlow
c0 -$50,000.00
c1 $50,000.00
c2 $55,000.00
c3 $60,500.00
c4 $66,550.00
Project 2
YEAR NetFlow
year 0 -$100,000.00
year 1 $72,000.00
year 2 $72,000.00
Year 3 $72,000.00
Year 4 $72,000.00
Project 3
YEAR NetFlow
year 0 -150,000.00
year 1 100,000.00
year 2 90,000.00
Year 3 81,000.00
Year 4 72,900.00

Solutions

Expert Solution

PROJECT 1 AND 2 SHOULD BE ACCEPTED SINCE THEY HAVE INCREASING AND CONSTANT CASH FLOWS RESPECTIVELY ALSO HAVE NOV GREATER THAN PROJECT C

CALCULATION OF DISCOUNT RATE

=(1+0.75) x (1+0.01)

=(1.075) x (1.01)

=1.08575

DISCOUNT RATE = 8.575%

PROJECT 1
CASH FLOWS PV FACTOR @8.575% PV OF CASH FLOWS
YEAR 0 -50000 -50000
YEAR 1 50000 0.921 46051.12
YEAR 2 55000 0.848 46655.52
YEAR 3 60500 0.781 47267.85
YEAR 4 66550 0.720 47888.22
ROR 8.58% NPV = 126974.63
PROJECT 2
CASH FLOWS PV FACTOR @8.575% PV OF CASH FLOWS
YEAR 0 -100000 -100000
YEAR 1 72000 0.921 66313.61
YEAR 2 72000 0.848 61076.31
YEAR 3 72000 0.781 56252.65
YEAR 4 72000 0.720 51809.95
ROR 8.58% NPV = 124754.79
PROJECT 3
CASH FLOWS PV FACTOR @8.575% PV OF CASH FLOWS
YEAR 0 -150000 -150000
YEAR 1 100000 0.921 92102.23
YEAR 2 90000 0.848 76345.39
YEAR 3 81000 0.781 63284.23
YEAR 4 72900 0.720 52457.57
ROR 8.58% NPV = 123591.46

jeff jeffy answered 1 year ago
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