Question

The CFO of Advo Corporation is considering two investment opportunties. The expected future cash inflows for each opportunity follow:

, Year 1 Year 2 Year 3 Year 4

Project 1 $144,000 $147,000 $160,000 $178,000

Project 2 204,000 199,000 114,000 112,000

Both investments require an initital of $400,000. dvo's desired rate of return is 16 percent.

a) Compute the net present value of each project. Which project should Advo adopt based on the net present value approach?

b) Use the incremental revenue summation method to compute the payback period for each project. Which project should Advo adopt based pn the payback approach?

1) What is meant by the expression, time value of money?

2) Why should all capital investment proposals include time value of money (present value) calculations of future cash flows that are to be received from the alternative investments?

Answer 1

Req A	Project 1
		Year	Cash Inflows	x DF at 16%*	= Present Value
		1	$144,000	0.862069	124,137.93
		2	147,000	0.743163	109,244.95
		3	160,000	0.640658	102,505.23
		4	178,000	0.552291	98,307.82
		Present value of cash inflows			434,195.92
		Cost of investment			(400,000)
		Net Present value			34,195.92
		*=1.16^-1 = 0.862069
	Project 2
		Year	Cash Inflows	x DF at 16%*	= Present Value
		1	$204,000	0.862069	175,862.07
		2	199,000	0.743163	147,889.42
		3	114,000	0.640658	73,034.97
		4	112,000	0.552291	61,856.60
		Present value of cash inflows			458,643.06
		Cost of investment			(400,000)
		Net Present value			58,643.06
	Project 2 having greater NPV , should be selected
Req B
	Cash Inflows	Project 1	Project 2
	Year 1	$144,000	$204,000
	Year 2	147,000	199,000
		$291,000	$403,000
	By the end of second year project 2 has crossed its initial investment of 400000
	But project 1 has falls short of (400000-291000) 109000, so project 2 should be selected
	Based on Payback
1	Time value of money concepts says that money available today in hands have more value than
	money available in future, its due to the effect of inflation and interest factor.
2	All capital investment proposal include time value of money since cash flows from alternative
	projects might have different values and to make them comparable, its necessary to discount
	their cash inflows for arriving at present value.