Question

McCormick and company is also considering introducing two new product lines to be made at the new factory (if it is purchased). as a new member of MCS's finance team, you are asked to determine whether McCormick and Company should invest in the two product line expansions. Project A has lower future cash flows than project B, but Project A is more closely related to McCormick's existing product line, the company feels that it is less risky than project B. You've done some more analysis and have formulated the following future profits for each project (with the first cash flow occurring one year from now). Each project is expected to have a life of five years. Project A Year 1 $5M Year 2 $10M Year 3 $10M Year 4 $15M Year 5 $15M Project B Year 1 $5M Year 2 $10M Year 3 $15M Year 4 $20M Year 5 $ 20M You also believe that each project will require about $40 million in upfront investment. Finally, based on the different risk assumptions, you believe that project A should use a discount rate of 7 percent, while Project B will have a discount rate of 20 percent. which project or projects should the company undertake?

Answer 1

In order to determine, which project should company pursue, we should first calculate the NPV of both the projects. NPV is the difference between the present value of cash inflows and the present value of cash outflows over a period of time.

A positive NPV implies the project will add value to the firm, whereas a negative NPV imply the project will erode firm's value.

A negative NPV for project B signifies that this project should be rejected. Company should take up Project A, for that would add value to the firm.