Question

You are financial analyst for the XYZ company. The director has asked you to analyze two proposed capital investments, Project A and Project B. Each project has a cost of RM 10, 000, and the cost of capital for each project is 12 percent. The project s’ cash flows are as follows:

Year	Expected Net Cash Flows
	Project A	Project B
0	(10,000)	(10,000)
1	6500	3500
2	3000	3500
3	3000	3500
4	1000	3500

1. Calculate each project’s NPV.
2. Which project or projects should be accepted?

Answer 1

NPV Project A = 966.0

NPV Project B = 630.7

Project A should be accepted

Explanation:-

Using formula

PV = FV / (1 + r)ⁿ

PV is present value, FV is future cash flow, r is rate of interest for period and n is the number of periods.

Rate = 12% = 0.12

i Compute NPV for the cash flows for the 4 years period

NPV Project A Computation

PV_A0 =-10000

PV_A1 = 6500 / (1 + 0.12)¹ = 6500 / 1.12 = 5803.6 (rounded)

PV_A2 = 3000 / (1 + 0.12)² = 3000 / 1.12² = 3000 / 1.254 = 2391.6 (rounded)

PV_A3 = 3000 / (1 + 0.12)³ = 3000 / 1.12³ = 3000 / 1.405 = 2135.3 (rounded)

PV_A4 = 1000 / (1 + 0.12)⁴ = 1000 / 1.12⁴ = 1000 / 1.574 = 635.5 (rounded)

NPV_ProjectA = PV_A0 + PV_A1 + PV_A2 + PV_A3 + PV_A4

                     = -10000 + 5803.6 + 2391.6 + 2135.3 + 635.5

                = 966.0

NPV Project B Computation

PV_B0 =-10000

PV_B1 = 3500 / (1 + 0.12)¹ = 3500 / 1.12 = 3125

PV_B2 = 3500 / (1 + 0.12)² = 3500 / 1.12² = 3500 / 1.254 = 2790.2 (rounded)

PV_B3 = 3500 / (1 + 0.12)³ = 3500 / 1.12³ = 3500 / 1.405 = 2491.2 (rounded)

PV_B4 = 3500 / (1 + 0.12)⁴ = 3500 / 1.12⁴ = 3500 / 1.574 = 2224.3 (rounded)

NPV_ProjectB = PV_B0 + PV_B1 + PV_B2 + PV_B3 + PV_B4

                     = -10000 + 3125 + 2790.2 + 2491.2 + 2224.3

                = 630.7

NPV Project A = 966.0

NPV Project B = 630.7

ii Determine project to be accepted

NPV_ProjectA > NPV_ProjectB

Project A should be accepted