ACC501 Business Finance Assignment 2 Solution Spring 2013

Mr. Ali has recently retired from his job and got handsome amount from his employer. He wants to invest his money in a profitable project. He got two different projects along with their initial costs and expected cash flows for next 6 years as follows:
Period
Project A
(Rs.)
Project B
(Rs.)
0
-250,000
-250,000
1
30,000
70,000
2
50,000
80,000
3
60,000
90,000
4
90,000
40,000
5
100,000
20,000
6
120,000
10,000
He doesn’t have enough knowledge to check the financial feasibility of projects. So, he approaches to a financial consultancy firm to get these projects evaluated regarding their financial viability. Being an employee of the financial consultancy firm, you have been assigned the task to analyze these projects by using the following capital budgeting techniques:
1. Payback period (Desired period is 4 year) [ 4 + 4 = 08 ]
2. Net Present Value (NPV) [ 7 + 7 = 14 ]
3. Profitability Index (PI) [ 3 + 3 = 06 ]
Considering both projects mutually exclusive, suggest which of the two projects is feasible and why? [ 1 + 1 = 2 ]
Note: Cost of capital for projects are 10%.

Solution:

payback-period-formula

NPV = Present value of future cash flows – Initial Investment

PVn = [CF1 / (1 + i)] + [CF2 / (1 + i)2] + [CF3 / (1 + i)3] + . . . . + CFn / (1 + i)n

 

OR

NPV = sum of all PV -Initial Investment

FOR PI

PI = sum of all PV / Initial investment

 

-250,000 + (30,000/1.10) + (50,000/1.10^2) + (60,000/1.10^3) +(90,000/1.10^4) + (100,000/ 1.10^5) + (120,000/1.10^6)

=5474.14 ans npv 1

i have calculated below

npv 1 is 54974

npv 2 is -7246

 

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