Question

1. Two investments (A and B, below) have been proposed to the Capital Investment committee of your organization;
   1. The required rate of return for your company is 15%. What is the NPV for each investment? Assume the initial investments ($150k and $50k) occur at the beginning of the year and all other costs and benefits occur at the end of the year indicated. Ignore inflation.

1. 2. What is the payback period for each investment?
2. 3. Which investment would you recommend and why?
3. 4. Why might you recommend the other investment?

Investment A	Year 1	Year 1	Year 2	Year 3	Year 4	Year 5
Costs:	$150,000	$5,000	$5,000	$5,000	$5,000	$5,000
Benefits:	-	$75,000	$55,000	$35,000	$20,000	$65,000
Investment B	Year 1	Year 1	Year 2	Year 3	Year 4	Year 5
Costs:	$50,000
Benefits:		$30,000	$15,000	$10,000	$10,000	$15,000

2. Unfortunately, the Capital Investment Committee refused to approve your recommendation (Problem 1) since you did not consider the uncertainty inherent in these types of investments. You pull out your very dog-eared notes from PMAN 635 and repeat your analysis, this time using Crystal Ball and the following information:

Investment A:

1. Year 0 Investment cost: Triangular distribution (optimistic: $125,000; most likely: $150,000; pessimistic: $200,000)
2. Year 1-5 operating cost: Normal distribution (mean of $5,000, standard deviation of $500)
3. Year 1 Benefits: Normal distribution (mean of $75,000, standard deviation of $20,000)
4. Year 2 Benefits: Normal distribution (mean of $55,000, standard deviation of $15,000)
5. Year 3 Benefits: Normal distribution (mean of $35,000, standard deviation of $10,000)
6. Year 4 Benefits: Normal distribution (mean of $20,000, standard deviation of $5000)
7. Year 5 Benefits: Uniform distribution (Minimum: $60,000; Maximum: $120,000)

Investment B:

0. 8. Year 0 Investment cost: Uniform distribution (Minimum: $40,000; Maximum: $60,000)
   9. Year 1 Benefits: Normal distribution (mean of $30,000, standard deviation of $3,000)
   10. Year 2 Benefits: Normal distribution (mean of $15,000, standard deviation of $5,000)
   11. Year 3 Benefits: Normal distribution (mean of $10,000, standard deviation of $3,000)
   12. Year 4 Benefits: Normal distribution (mean of $10,000, standard deviation of $3,000)
   13. Year 5 Benefits: Normal Distribution (mean of $15,000, standard deviation of $5000).
1. If the IRR is still 15%, use Crystal Ball to calculate the median NPV for each investment. Would you still prefer the same investment you recommended in question 1.c?

2. What is the probability that Investment B will be better than Investment A (financially)?

Be sure to show all work

Answer 1

Given, Required rate of return = 15% per annum

(a)

Note:

• Values are rounded off to two decimals.
• NPV - Net Present Value
• Inv-A stands for Investment A
• Inv-B stands for Investment B
• Value in brackets represent Outflows
• Normal values represent inflows