Question

The Cosmetics Company has to decide whether to introduce beauty cream A or beauty cream B on the ...

The Cosmetics Company has to decide whether to introduce beauty cream A or beauty cream B on the market. The initial cost of introducing each cream is $1 million and the net cash flows generated by each are indicated in the following table. Using the discount rate of 10 percent, determine:

(a)the net present value

(b)the internal rate of return on investment projects A and B

(c)Which project (cream) should the firm undertake? Why?

Net Present Value and Internal Rate of Return on Two Mutually Exclusive Investment Projects

                                                                    Project A                                         Project B

Initial Cost                                                   $1,000,000                                       $1,000,000

Net Cash Flows (years)

Year 1                                                       $300,000                                          -100,000

Year 2                                                        $300,000                                            10,000

Year 3                                                       $300,000                                             300,000

Year 4                                                       $300,000                                           300,000

Year 5                                                       $300,000                                            1,400,000

Answer 1

Solution:

Given

Cosmetics Company has to decide whether to introduce beauty cream A or beauty cream B on the market.

(a) the net present value:

NPV is computed as follows.

Project - A
Year	Cash Flow ($)	PV Factor at 10%	Discounted Cash Flow ($)
0	-10,00,000	1.0000	-10,00,000
1	3,00,000	0.9091	2,72,727
2	3,00,000	0.8264	2,47,934
3	3,00,000	0.7513	2,25,394
4	3,00,000	0.6830	2,04,904
5	3,00,000	0.6209	1,86,276
		NPV ($) =	1,37,236
Project - B
Year	Cash Flow ($)	PV Factor at 10%	Discounted Cash Flow ($)
0	-10,00,000	1.0000	-10,00,000
1	-1,00,000	0.9091	-90,909
2	10,000	0.8264	8,264
3	3,00,000	0.7513	2,25,394
4	3,00,000	0.6830	2,04,904
5	14,00,000	0.6209	8,69,290
		NPV ($) =	2,16,944

(b) the internal rate of return on investment projects A and B:

IRR is computed using Excel function =IRR() as follows.

Project - A
Year	Cash Flow ($)
0	-10,00,000
1	3,00,000
2	3,00,000
3	3,00,000
4	3,00,000
5	3,00,000
IRR =	15.24%
Project - B
Year	Cash Flow ($)
0	-10,00,000
1	-1,00,000
2	10,000
3	3,00,000
4	3,00,000
5	14,00,000
IRR =	14.65%

(c) project (cream) should the firm undertake

Even though project B has lower IRR, it has higher positive NPV and therefore, B should be chosen.