Question

Q1. A pharmaceutical company developed four investment plans. The initial investment and the corresponding annual cash flows of the four investment plans for consecutive J years are shown in the following Table Q1. Project Name I II III IV Initial Investment (OMR) A B C D Annual Cash inflow (OMR) E F G H Identify the best project and decide the ranking based on the following profitability methods. a) Average rate of return. b) Payback period. c) Net Present value with discounting rate at 8% d) Benefit to cost ratio with discounting rate at 11% e) Internal rate of return for range of suitable discounting rate [40 Marks]

Where A= 60000

B=65000

C=87000

D=106000

E=14000

F=20000

G=33000

H=44000

number of years= 9 years

Answer 1

A) Average rate of return = average income / initial investment

Project I

ARR = 14,000 / 60,000 = 23.33%

Project II

ARR = 20,000 / 65,000 = 30.77%

Project III

ARR = 33,000 / 87,000 = 37.93%

Project IV

ARR = 44,000 / 106,000 = 41.51%

Rank ( best to worse)

1. Project IV

2. Project III

3. Project II

4. Project I

B) Payback Period = full year before recovery + Amount left to be restored / amount in the year of recovery

Project I

Payback period = 4 + 4,000 / 14,000

= 4 + 0.29

= 4.29 years

Project II

Payback Period = 3 + 5,000 / 20,000

= 3 + 0.25

= 3.25 years

Project III

Payback period = 2 + 21,000 / 33,000

=2 + 0.64

= 2.64 years

Project IV

Payback period = 2 + 18,000 / 44,000

= 2 + 0.41

= 2.41 years

Rank ( Best to worse)

1. Project IV

2. Project III

3. Project II

4. Project I

C) NPV

Project I

Using financial calculator to calculate Npv

Inputs: C0= -60,000

C1= 14,000. Frequency= 9

I= 8%

Npv= compute

We get, the NPV of the project as $ 27,456.43

Project II

Using financial calculator to calculate NPV

Inputs: C0 = -65,000

C1= 20,000. Frequency= 9

I= 8%

Npv = compute

We get, the NPV of the project as $59,937.76

Project III

Using financial calculator to calculate the Npv

Inputs: C0= -87,000

C1= 33,000. Frequency= 9

I = 8%

Npv= compute

We get, the NPV of the project as $119,147.30

Project IV

Using financial calculator to calculate the Npv

Inputs: C0= -106,000

C1= 44,000. Frequency= 9

I= 8%

Npv= compute

We get, Npv of the project as $168,863.07

Rank ( Best to worse)

1. Project IV

2. Project III

3. Project II

4. Project I

D) Benefit / cost ratio

Project I

Using financial calculator to calculate present value of benefit

Inputs: C0= 0

C1= 14,000. Frequency= 9

I = 11%

Npv= compute

We get, present value of benefit of the project is $77,518.67

Benefit cost ratio = Present value of benefits / initial investment

= 77,518.67 / 60,000

= 1.3

Project II

Using financial calculator to calculate the present value of benefits

Inputs: C0= 0

C1= 20,000. Frequency= 9

I= 11%

Npv= compute

We get, present value of the benefit of the project as $110,740.95

Benefit cost ratio = Present value of benefits / initial investment

= 110,740.95 / 65,000

= 1.7

Project III

Using financial calculator to calculate present value of benefits

Inputs: C0= 0

C1= 33,000. Frequency= 9

I= 11%

Npv= compute

We get, the present value of benefits of the project as $182,722.57

Benefit cost ratio = Present value of benefits / initial investment

= 182,722.57 / 87,000

= 2.1

Project IV

Using financial calculator to calculate the present value of the benefits

Inputs: C0 = 0

C1= 44,000. Frequency= 9

I= 11%

Npv= compute

We get, the present value of the benefits of the project as $243,630.09

Benefit cost ratio= present value of benefits / initial investment

= 243,630.09 / 106,000

= 2.3

Rank (best to worse)

1. Project IV

2. Project III

3. Project II

4. Project I