Question

Section 3 (15 Marks) ICLO 3] ABC Company is expanding its product line and its production capacity. The expected future cash flows of its three independent projects are given in the following table The company uses a discount rate of 8% 4 Year 15,00020,000 10,000 5,000 Cash flow -Project A -50,000 15,000 Cash flow -Project B -50,000 15,00010,000 10,000 10,000 10,000 Cash flow -Project C -100,000 35,000 35,000 40,000 40,000 5,000 Instructions: 1. Calculate the cumulative cash flow for the three projects (3 Marks). 2. Calculate the NPV for each project (3 Marks). 3. Calculate the IRR for each project (3 Marks).

Answer 1

Cumulative cash flow is the addition of previous year cash inflow or outflow to the current year cash flow.

Project A:

Project A Year Cash Flow Cumulative cash flow 0 50,000 1 15,000 2 15,000 3 20,000 4 10,000 5,000 50,000 35,000 20,000 10,000 15,000

Project B:

Project B Year Cash Flow Cumulative cash flow 0 50,000 1 15,000 2 10,000 3 10,000 4 10,000 5 10,000 50,000 35,000 25,000 15,000 5,000 5,000

Project C:

Project C Year Cash Flow Cumulative cash flow 0 100,000 1 35,000 2 35,000 3 40,000 4 40,000 100,000 65,000 30,000 10,000 50,000 55,000 5,000

Part 2:

NPV of Project A:

Project A Year Cash Flow Discounted Cash Flow 0 50,000 1 15,000 2 15,000 3 20,000 4 10,000 50,000 13,889 12,860 15,877 7,350 3,403 3,379 2 5,000 NPV

NPV of Project B:

Project B Year Cash Flow Discounted Cash Flow 0 50,000 1 15,000 2 10,000 3 10,000 4 10,000 5 10,000 NPV 50,000 13,889 8,573 7,938 7,350 6,806 5,443

NPV of Project C:

Project C Year Cash Flow Discounted Cash Flow 0 100,000 1 35,000 2 35,000 3 40,000 4 40,000 100,000 32,407 30,007 31,753 29,401 3,403 26,972 5,000 NPV

Question 3

IRR of project A:

Project A Year Cash Flow 0 50,000 1 15,000 2 15,000 3 20,000 4 10,000 5,000 IRRI 10.88%

IRR of project B:

Project B Year Casih Flow 0 50,000 1 15,000 2 10,000 3 10,000 4 10,000 5 10,000 IRRI 3.49%

IRR of Project C:

Project C Year Cash Flow 0100,000 1 35,000 2 35,000 3 40,000 4 40,000 5,000 IRRI 18.95%

Question 4:

Profitability index for project A:

PI = (NPV + Initial Investment)/ Initial Investment

PI = (3,378.83 + 50,000)/ 50,000

PI = 1.07

Profitability index for project B:

PI = (NPV + Initial Investment)/ Initial Investment

PI = (-5,443.17 + 50,000)/ 50,000

PI = 0.89

Profitability index for project C:

PI = (NPV + Initial Investment)/ Initial Investment

PI = (26,971.67 + 100,000)/ 100,000

PI = 1.27

Part E

We will select project C as it has higher NPV value as compare to other projects and also has higher IRR