Question

Q Corporation is considering investing in the following projects:

	Project A		Project B
Initial cash outlay	$(200,000)		$(140,000)
Future cash inflows:
Year 1	$ 50,000		$ -
Year 2	50,000		-
Year 3	50,000		-
Year 4	50,000		40,000
Year 5	50,000		90,000
Year 6	50,000		140,000
Total cash inflows	$300,000		$ 270,000

The company’s cost of capital is 8%, which is an appropriate discount rate.


Required:

1. Compute the net present value of each project. Use a clear presentation of the solution for full marks.

2. Assume Q Corporation has limited funds to invest and is considering two projects, both with positive net present values. Explain (no calculations needed) how the two projects should be ranked. A clear and well worded accurate explanation will earn full marks

Answer 1

a.Project A

Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$200,000. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the cost of capital of 8%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 8% cost of capital is $31,143.98.

Project B

Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$140,000. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the cost of capital of 8%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 8% cost of capital is $38,877.43.

The projects should be ranked based on the value of the net present value. Project B should be ranked first since it has the largest net present value and Project A should be ranked second.