Question

Uneven cash flows		show formulas
Western Ranch Corporation is considering the two following projects with amounts in SAR.
(a) Calculate the NPV for each project assuming a discount rate of 10%.
(b) Explain which project is better and why.
			Project A	Project B
Cash outflow:			(40,000,000)	(40,000,000)
Cash Inflows:			6,000,000	22,000,000
			9,000,000	18,000,000
			18,000,000	9,000,000
			22,000,000	6,000,000

Answer 1

The NPV is computed as shown below:

= Initial investment + Present value of future cash flows

Present value is computed as follows:

= Future value / (1 + r)ⁿ

The NPV of project A is computed as follows:

= - SAR 40,000,000 + SAR 6,000,000 / 1.10 + SAR 9,000,000 / 1.10² + SAR 18,000,000 / 1.10³ + SAR 22,000,000 / 1.10⁴

= SAR 1,442,524.418

The NPV of project B is computed as follows:

= - SAR 40,000,000 + SAR 22,000,000 / 1.10 + SAR 18,000,000 / 1.10² + SAR 9,000,000 / 1.10³ + SAR 6,000,000 / 1.10⁴

= SAR 5,735,946.998

B. Since the investment in both of these projects are equal, hence the firm shall choose the project which will generate a higher NPV, since it will lead to more value to the firm.

In the present case, since the NPV of project B is greater as compared to the NPV of project A, hence Project B shall be considered.

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