Question

1. Consider projects A and B: Cash Flows (dollars)

	Projects
	A	B
C0	450,000	320,000
C1	310,000	80,000
C2	120,000	100,000
C3	85,000	250,000

What is the NPV at 10% required rate? Which is the best Project?

Answer 1

Given about Project A,

Initial cost C0 = $450000

Cash flow in year 1 CF1 = $310000

Cash flow in year 2 CF2 = $120000

Cash flow in year 3 CF3 = $85000

discount rate d = 10%

NPV of the project is sum of Present value of cash flows minus initial cost. NPV is calculated using formula

PV = CF1/(1+d) + CF2/(1+d)^2+ CF3/(1+d)^3 - C0

=> PV = 310000/1.10 + 120000/1.10^2 + 85000/1.10^3 - 450000 = -5146.51

Similarly, given about project B,

Initial cost C0 = $320000

Cash flow in year 1 CF1 = $80000

Cash flow in year 2 CF2 = $100000

Cash flow in year 3 CF3 = $25000

discount rate d = 10%

NPV of the project is sum of Present value of cash flows minus initial cost. NPV is calculated using formula

PV = CF1/(1+d) + CF2/(1+d)^2+ CF3/(1+d)^3 - C0

=> PV = 80000/1.10 + 100000/1.10^2 + 250000/1.10^3 - 320000 = $23200.60

Since NPV of project B is positive, this investment is better.