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Assume that your firm wants to choose between two project options:
Project A: Br. 500,000 invested today will yield an expected income stream of Br150, 000 per year for 5 years, starting in Year 1.
Project B: an initial investment of Br 400,000 is expected to produce this revenue stream: Year 1 = 0, Year 2 = Br 50,000, Year 3 = Br 200,000, Year 4 = Br300, 000, and Year 5 = Br200, 000. Assume that a required rate of return for your company is 10% and that inflation is expected to remain steady at 3% for the life of the project. Which is the better investment? Why?

Sagot :

Answer:

Project B should be the better investment

Explanation:

The computation is shown below;

Project A Cash Flow      Discount Factor      New Inflows

(Present Value)

Year

0                ($500,000)             1.000                      ($500,000)

1                 $150,000                0.885                     $132,743

2                $150,000                 0.783                   $117,472

3                 $150,000                0.693                    $103,958

4                 $150,000                0.613                    $91,998

5                 $150,000               0.543                     $81,414

NPV Total                                                                $27,585

Project B Cash Flow Discount Factor New Inflows

(Present Value)

Year

0                     ($400,000)       1.000                        ($400,000)

1                         $0                   0.885                        $0

2                      $50,000           0.783                       $39,157

3                      $200,000         0.693                       $138,610

4                      $300,000          0.613                        $183,996

5                      $200,000         0.543                           $108,552

NPV total                                                                   $70,315

Based on the above calculations, the project B contains high net present value as compared with the project A so Project B should be the better investment

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