Question

(iii) Projects A and B are competing for funds. With an original investment of €1,000 and returns given in Table Q3, determine using appropriate project financing evaluation techniques whether the company should choose projects A or B? Provide calculations to justify your recommendation. Use 10% discount rate in your calculations.

Table Q3 - Table of project returns Project A Project B Year 1 €200 €O Year 2 €500 Year 3 €400 €700 Year 4 €0 €700 Year 5 €500 €500 €0 [7 marks]

Answer 1

Answer :

Discount rate = r = 10% = 0.1

Net Present Value formula = -C0/(1 + r)^0 + C1/(1 + r) + C2/(1 + r)^2 + C3/(1 + r)^3 + C4/(1 + r)^4 + C5/(1 + r)^5

Here C0 is 1000 for both the projects, that is the initial investment

1 + r = 1 + 0.1 = 1.1

Project A

NPV = -1000/1.1^0 + 200/1.1 + 500/1.1^2 + 400/1.1^3 + 0/1.1^4 + 500/1.1^5 = 206.03

Project B

NPV = -1000/1.1^0 + 0/1.1^1 + 0/1.1^2 + 700/1.1^3 + 700/1.1^4 + 500/1.1^5 = 314.49

Thus going by the calculations we can say that Project B is more profitable than project A since the NPV is higher (Net Present Value) and thus the company should choose Project B.