Question

Suppose your firm would like to earn 10% yearly return from the following two investment projects of equal risk.(the table is attatched in the form of image)

(a)​If only one project can be accepted, based on the NPV method which one should it be? Support your answer with calculations. ​​​​​​(9 marks)

(b)​Suppose there is another four-year project (Project C) and its cash flows are as follows:

​

C0 = –$8,000

​C1 = $2,000

​C2 = $2,500

​C3 = $2,000

​C4 = $4,000

(i)​Given the above cash flow patterns, at what required rate of return will Project C have the same NPV as Project B? Briefly explain your answer.​​​(2 marks)

(ii)​If Project C has the same risk as Project B, without calculations, explain which project will you pick? ​​​​​​​​​(2 marks)

(iii)​If cash flow C4 of Project C is unknown to you (while C0 – C3 are known and as above) and the project’s cost of capital is 10%, what amount of C4 will make Project C worth accepting?​​​​​​​​​(4 marks)

(iv)​If your firm’s investment policy (based on payback method) is such that it only accepts projects whose initial investment can be recouped within three years, will Project B and/or Project C be accepted?​​​​​​​(2 marks)

(c)​Based on the estimated cash flows of Project A, will you expect its internal rate of return (IRR) to be positive? Briefly explain your answer WITHOUT calculations. ​(4 marks)

(d)​What kind of rate of return is the 10% interest stated in the question for Projects A and B? How can it be used in making investment decisions (i.e. its role in investment decision making)?​​​​​​​​​​(2 marks)

Please provide steppings for all if possible, much appreciated.

Question 4 (25 marks/Investment Decision Rules). Suppose your firm would like to earn 10% yearly return from the following two investment projects of equal risk. Year (t Cash flows from Project Cash flows from Project A (C) BC) 0 -$8,000 $8,000 $2,000 $4,000 $3,000 $2,000 3 $5,000 $2,500 4 $1,000 $2,000 2

Answer 1

A) Statement showing NPV

	Project A			Project B
Year	Cash Flow	PVIF @ 10%	PV	Cash Flow	PVIF @ 10%	PV
0	-8000	1.0000	-8000	-8000	1.0000	-8000
1	2000	0.9091	1818	4000	0.9091	3636
2	3000	0.8264	2479	2000	0.8264	1653
3	5000	0.7513	3757	2500	0.7513	1878
4	1000	0.6830	683	2000	0.6830	1366
NPV(Sum of PV)			737			534

Thus Project A should be selected

B)

i) Let us assume rate to be 8%

Statement showing NPV of project C

	Project C
Year	Cash Flow	PVIF @ 8%	PV
0	-8000	1.0000	-8000
1	2000	0.9259	1852
2	2500	0.8573	2143
3	2000	0.7938	1588
4	4000	0.7350	2940
NPV(Sum of PV)			523

Now, Let us assume rate to be 7%

	Project C
Year	Cash Flow	PVIF @ 7%	PV
0	-8000	1.0000	-8000
1	2000	0.9346	1869
2	2500	0.8734	2184
3	2000	0.8163	1633
4	4000	0.7629	3052
NPV(Sum of PV)			737

Now using interpolation method we can find rate

Rate	NPV
8%	523
7%	737
1% down	214
?	11

1*11/214

=0.0514

Thus rate = 8%- 0.0514%

=7.9485%

II) Project C, Since its has low cost of capital

III) Assuming Cash flow for Year 4 = 3826$

	Project C
Year	Cash Flow	PVIF @ 10%	PV
0	-8000	1.0000	-8000
1	2000	0.9091	1818
2	2500	0.8264	2066
3	2000	0.7513	1503
4	3826	0.6830	2613
NPV(Sum of PV)			0

Thus cash flow above 3826$ is required

iv) Project B as sum of it's 3 year cash flow is 8500$ ( 4000+2000+2500)

C) Yes, IRR will be positive for project A , since there are conventional cash flows i.e No negative cash flow after initial period

D) 10% Rate used can be called minimum required rate of return. i.e if one wants to start project , he/she will have to raise funds. the cost of funds suppose is 10%, thus they want project which have atlease 10% return so that they can break even.