Question

1. Mr. Mike has a commercial land near Monash University. He is planning to consider the different uses of this land. Recently, he has been approached with an offer to buy it for $220,000. Moreover, he is also considering three alternative business projects: X, Y, and Z. He is thinking of operating his business choice indefinitely. He has collected the following information about the uses.

Alternatives	Initial Investment	Cash flow in the First Year (CF1)	Growth Rate (g)	Cost of Capital ( r)
X	$400,000	$60,000	3.5%	12%
Y	$200,000	$40,000	3%	10%
Z	$500,000	$75,000	3%	13%

What is his ranking of these projects based on NPV? Where should we rank the first choice (selling the land) if we take it as NPV?

Answer 1

Present value of cashflows = Cash flow year 1 * ( 1 + growth rate ) / ( cost of capital - growth rate )

Npv = Present value of cash inflwos - Initial Investment

Alternative X :

Present value of cashflows = 60000*1.035 / ( 0.12 - 0.035 ) = 730588.20

Npv for X = 740588.2 - 400000 = 340588.20

Alternative Y :

Present value of cashflows = 40000*1.03 / ( 0.10 - 0.03 ) = 588571.4

Npv for Y = 588571.4 - 200000 = 388571.4

Alternative Z :

Present value of cashflows = 75000*1.03 / ( 0.13 - 0.03 ) = 772500

Npv for Y = 772500 - 500000 = 272500

Ranking of Projects based on NPV

Rank 1 : Alternative Y

Rank 2 : Alternative X

Rank3 : Alternative Z

The selling the land will be Rank 4 .