Question

Part C. Problem Solving (12 pts. total): 31. Examine the cash flows (in thousands of Dirhams) for the following project (called Project X). with discounting factors (PVFs) over a three-year period (Note: cash flows occur at the end of each year): ons 0.79 Projects: Cost/Benefits Year 1 Year 2 Year 3 Total PVF: 0.93 0.86 Costs 200 500 600 1,300 Project X Benefits 100 900 500 1,500 Net cash flow - 100 400 Required: D.ct -93 344 1) Compute and find each of the following criterion for the project (show all your calculations) (6 pts): A. Net present value (NPV) B. Rate of return on investment (ROI)--rounded to 2 decimals C. Payback period --100 -79 II) Determine using each criterion individually and separately whether to accept (feasible) or to reject (infeasible) the project assuming the following requirements or decision rules (3 pts.) a. Projects are required to have positive NPVs b. The required rate of return for any project is 15% C. The required payback period is 2 years IIT Suppose there is another project (call it Project Y) with an NPV of 200,000, ROI of 18%, and a payback period of 3 years. Which (and why) of the two projects would you recommend if only one of the two projects must be selected? Justify and support your answer by discussing the drawbacks and trade-offs between the three selection-criteria (3 pts.). 3

Answer 1

Please find the solution in given screen shots,

Amount in Dirhams (thousands)

II) a cost 500 Calculation of PV of Cost & Benefit and NPV Project X Year 1 Year 2 PVE PVF 0.93 200 Benefit 100 Net Cash flow -100 Discounted Cash flow of Cost 186 Discounted Cash flow of Benefit 93 Discounted Cash flow Year 3 Total Remarks 0.86 0.79 600 1300 900 500 1500 400 -100 200 Benefit minus Cost 430 1090 Cost Multiplied by PVF 774) 395 1262 Benefit Multiplied by PVF 344 -79 172 Net Cash Flow Multiplied by PVF -93 NPV = sum of discounted cash flows = (-93+344-79) = 172 NPV 11) b ROI = [(PV of Expected Value - PV of Original Value) / PV of Original Value] 100 ROI = [(1262 - 1090)/1090] x 100 15.78% II) PV - Cost Till Year 1 Till Year 2 Till Year 3 PV - Benefit 186 616 8671 1090 1262

We can see that Cost at Year 1 is not recovered in Year 1 but cost till Year 2 is completely recovered in by the benefit till Year 2 hence Payback period is more than one year and less than one year - the exact period is calculated as below Benefit or Year 2 Per month benefit 774 64.5 Unrecovered cost of year 1 & year 2 Year 1 186-93 Year 2 Total We need to recover cost of 709 by 64.5 per month benefit hence =709/64.5 10.99 months So the payback period is Year 1 +10.99 months from year two we can say Payback period = 1 Year and 11 months 11) a Accept - because NPV is positive. 11) b Accept - because ROI is more than of 15% II) Accept - because Payback period is less than 2 years

NPV ROI 200 Payback Period 18% 3 Years Project Y Reason to recommend both the projects 1) Both the projects have positive NPV 2) Both the projects meets the required rate of return criteria which is 18% If only one of the two projects must be selected Project Y should be selected as it has ROI of 18% against 15.78% of Project Y Project X has NPV of 172 thousands and Y 200 thousands As per the criteria of NPV both the projects give positive NPV at the same discounted rate (required rate of return) Lets assume required rate of return for the given PVF is 7.5%. Since both the projects gives more than of 7.5% as the NPVs are positive - both can be accepted. If we need to choose between both then obviously we will go for the one with higher NPV - Project Y ROI for Project X is 15.78% and for Y is 18% - it's the basic and overall criteria where shareholders will be interested into No matter how much is the amount if rate of return is better - shareholders will go with that. hence Project Y should be selected based on ROI. Payback period is less than 2 years for X and for Y its 3 years. I have considered discounted pay back period for better decision making. Though the payback period is better for X its not recommended to choose X over Y. No matter what is the amount of money the concern is how much we earn on it. The ROI is much better than Xhence Y should be selected.

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