A manager of “Safola Co. “ ask your advice to evaluate 3 projects, consider the following information to determine the project the manager should be select by the following criteria’s:
Projects |
A |
B |
C |
Cost |
100000 |
150000 |
200000 |
Expected of cash inflows |
20000 |
25000 |
30000 |
Life( years) |
7 |
9 |
10 |
Level of risk ( c.v) |
0.24 |
0.34 |
0.18 |
Safola Co. usually uses the following discount rates 10%, 7%, 12%, and certainty factors 0.633, 0.742, 0.543.
Solution : | Calculation fo Net present value using certainty factors | |||
Amount in $ | ||||
Projects | A | B | C | |
(a)Annual Cash inflow | 20000 | 25000 | 30000 | |
(b) Certainty equivalent(Certainty factors) | 0.633 | 0.742 | 0.543 | |
(c ) Adjusted cash inflow(a*b) | 12660 | 18550 | 16290 | |
Discount Rate | 10% | 7% | 12% | |
Life | 7 | 9 | 10 | |
(d) Present value of annuity factor | 4.8684 | 5.8852 | 5.6502 | |
(e) Present value of Adjusted cash inflows (c*d) | 61634 | 109170 | 92042 | |
Less: Initial Cost | -100000 | -150000 | -200000 | |
Net Present Value (NPV) | -38366 | -40830 | -107958 | |
Selection criteria should be: project which has positive NPV | ||||
However, in a given case, Non of the project has positive NPV. Further, Project A has lower negative NPV which is best option out of 3 projects. |
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