Question

3.         The cash flow in respect of two projects is given below. The cost of capital is 8.5%.

Year	Project A	Project B
0	(200)	(300)
1	65	100
2	65	100
3	65	90
4	60	70
5	60	70

Answer the following question using the above information.

I           What is the NPV of Project A? Should this project be accepted?

II         What is the NPV of Project B? Should this project be accepted?

III        What is the Accounting rate of return (ARR) of Project A?

IV        What is the Accounting rate of return (ARR) of Project B?

V         What is the IRR of Project A? Use graphical and linear interpolation method.

VI)      What is the IRR for Project B? Use graphical and linear interpolation method.

VII)     What is the discounted payback period for Project A and B?

Answer 1

Project A

Years	Amount	Discounting Factor	Present value
1	65	0.921658986	59.9078341
2	65	0.849455287	55.21459364
3	65	0.782908098	50.8890264
4	60	0.721574284	43.29445706
5	60	0.665045423	39.9027254
Total Present value of cash inflows ( A)			249.2086366
Less : Cash outflow (B)			200
NPV (A -B)			49.21

Project A should be accepted

Discounting factor = 1 /( 1 +r)^n

r is the rate of interest

n is the no years from year 0

Project B

Years	Amount	Discounting Factor	Present value
1	100	0.921658986	92.16589862
2	100	0.849455287	84.94552868
3	90	0.782908098	70.46172886
4	70	0.721574284	50.5101999
5	70	0.665045423	46.55317963
Total Present value of cash inflows ( A)			344.6365357
Less : Cash outflow (B)			300
NPV (A -B)			44.64

Project B should be accepted

Accounting rate of return (ARR) = average Net profit / Average invetsment

Project A

Years	Amount
1	65
2	65
3	65
4	60
5	60
Total inflows	315
Less cash outflow	200
Income	115
Years	5
Average income	23

Project B

Years	Amount
1	65
2	65
3	65
4	60
5	60
Total inflows	315
Less cash outflow	200
Income	115
Years	5
Average income	23

Accounting rate of return (ARR) of Project A = 23 / 200 = 11.5%

Accounting rate of return (ARR) of Project B = 26/300 = 8.67%