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

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

Solutions

Expert Solution

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.

Rahul Sunny answered 1 year ago
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