Question

Year	Project A	PROJECT B	PROJECT C
0	(R28000)	(R68000)	(R15000)
1	R11000	R42000	R11000
2	R11000	R18000	R4000
3	R11000	R15000	R2000
4	R11000	R18000	R1000

Suddy limited is considering investing in one of three potential projects.The details of the three projects being considered are summerized above

Present value factors based on 10% cost of capital for project duration:

year 1 = 0.909

year 2 = 0.826

year 3 = 0.751

year 4 = 0.683

Required :

1- Determine which of the above projects has the shortest payback period

2- Determine which of the above projects has the highest net present value. Assume the cost of capital to be 10%

3- Briefly discuss the merits of the NPV Methods

Answer 1

Payback period = Y + ( A / B ) where

Y = The number of years before the payback year.

A =Total remaining to be paid back at the start of the break even year. This is the amount that brings cumulative cash flow to 0.

B = Total (net) cash inflow in the entire payback year.

Project A

Payback period = Y + ( A / B )

                             =2+ (6000/11000)

                        =2+0.55

                           =2.55 years

Project B

Payback period = 2+ (8000/15000)

                        =2+0.53

                           =2.53 years

Project C

Payback period = 1+ (4000/4000)

                          =1+1

                           =2.0 years

Project C has the shortest payback period.

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Project wth highest NPV

NPV = -Cq + C1 /1+r + C2 /(1+r)2 + .... + CT /(1+r)T

where -Cq =Initial investment

C =Cash inflow

r= discount rate

T= Time

NPV of project A

   = -(28000) + 11000/1+0.1 + 11000/ (1+0.1)2 +11000/ (1+0.1)3+11000/ (1+0.1)4

   = -$4320

NPV of project B

   = -(68000) + 42000/1+0.1 + 18000/ (1+0.1)2 +15000/ (1+0.1)3+18000/ (1+0.1)4

   = -$8672

NPV of project C

   = -(15000) + 11000/1+0.1 + 4000/ (1+0.1)2 +2000/ (1+0.1)3+1000/ (1+0.1)4

   = -$1980

Project C has the Highest NPV

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Advantages Of Net Present Value (NPV)

1. NPV gives important to the time value of money.

2.In the calculation of NPV, both after cash flow and before cash flow over the life span of the project are considered.

3. Profitability and risk of the projects are given high priority.

4. NPV helps in maximizing the firm's value.