Question

14. Consider the fol asider the following two new chemical plants, each with an initial fixed capital investment C) of $15 x 10°. Their cash flows are as follows: Year Process 1 ($million/y) Process 2 (Smillionly) 5.0 7.0 5.0 2.0 2. Calculate the NPV of both plants for interest rates of 6% and 18%. Which plant do you rec- ommend? Explain your results. b. Calculate the DCFROR for each plant. Which plant do you recommend? c. Calculate the nondiscounted payback period (PBP) for each plant. Which plant do you recommend? d. Explain any differences in your answers to Parts (a), (b), and (c).

Answer 1

Present value of cash outflow is $15 million Discounted factor @21 for value of Present Discounted Present Process1($ Process2($ Discounted Discounted million/y) million/y) value of Present value Present value factor @21 Process 2 Year factor @ 6% factor @ 18% of Process 1 for process 1 Process 1 process 1 1.199 of Process 2 4.24 4.17 5 1.88 2.48 1 3 1.6 1.18 1.21 2 3.48 8 5.46 5 2.56 1.39 3.13 3.6 1.464 1.438 1.724 1.71 3.05 5 3.95 2.9 7 4.1 1.64 1.772 4 2.067 2.478 2.144 2.33 2.42 2.02 15 5 5 6.55 1.94 0.76 2.58 2.29 2.18 2.594 0.19 0.77 5 2 10.49 15.65 0.65 Total Present Value 7.67 15 NPV(Present value of cash inflow- present value of outflow) 0 -7.33 According to NPV method Process 2 will be preferred as NPV is positive sum of present value of cash inflow DCFROR 0 (1+)" DCFROR for Process 1-21 DCFROR for Process 2 19.9 According to DCFROR Process 1 will be preferred as DCFROR is higher

Process1($ Process2($ million/y) million/y) Year 3 5 2 8 5 7 5 4 5 5 5 2 5 Period Cash inflow Calculation of Non-discounted pay back period for Process1 3+8+4 15 2.5 Calculation of Non-discounted pay back period for Process2 5+5+5 15 3 According to non-discounted method Process 1 will be preferred as the period is less NPV method shows whether a project will be profitable or not whereas DCFROR shows when the project would reach the breakeven point Non-discounted period does not take time value into account Hence NPV is the most preferred method LO LO LO