Question

You work for the 3T company, which expects to earn at least 18 percent on its investments. You have to choose between two similar projects. Below is the cash flow information for each project. Calculate the NPV of each project. (Use the NPV function in Excel to solve this problem.) Which of the two projects would you fund if the decision is based only on financial information and you could only choose one of the projects? Omega Alpha Year Inflow Outflow Netflow Year Inflow Outflow Netflow Y0 0 219,000 (219,000) Y0 0 211,000 (211,000) Y1 0 180,000 (180,000) Y1 0 150,000 (150,000) Y2 150,000 0 150,000 Y2 150,000 0 150,000 Y3 220,000 30,000 190,000 Y3 220,000 30,000 190,000 Y4 197,000 0 197,000 Y4 173,000 0 173,000 Y5 205,000 36,000 169,000 Y5 205,000 44,000 161,000 Y6 197,000 0 197,000 Y6 197,000 0 197,000 Y7 100,000 30,000 70,000 Y7 100,000 30,000 70,000 Total 1,069,000 495,000 574,000 Total 1,045,000 465,000 580,000

Answer 1

We will compute the PV (Present Value ) of the net cash flows for both the projects using the following method and compare them to select the better alternative.

Present Value, PV of a cash flow of amount 'C' at period-n is computed as PV = C / (1+r)ⁿ, .
C = netflow or Netcash flow (= inflow-outflow)
r = rate of return (18% here)

Rate of Return,r = 18%	Netflow		PV of Cashflow (PV = C / (1+r)n)
Year	Omega	Alpha	Omega	Alpha
0	(219,000.00)	(211,000.00)	(219,000.00)	(211,000.00)
1	(180,000.00)	(150,000.00)	(152,542.37)	(127,118.64)
2	150,000.00	150,000.00	107,727.66	107,727.66
3	190,000.00	190,000.00	115,639.87	115,639.87
4	197,000.00	173,000.00	101,610.41	89,231.48
5	169,000.00	161,000.00	73,871.46	70,374.58
6	197,000.00	197,000.00	72,975.01	72,975.01
7	70,000.00	70,000.00	21,974.75	21,974.75
Total	574,000.00	580,000.00	122,256.79	139,804.71
			NPV	NPV

Using NPV FUnction on Excel

Omega				Alpha
Year	Inflow	Outflow	Netflow	Year	Inflow	Outflow	Netflow
Y0	0	219,000	-219,000	Y0	0	211,000	-211,000
Y1	0	180,000	-180,000	Y1	0	150,000	-150,000
Y2	150,000	0	150,000	Y2	150,000	0	150,000
Y3	220,000	30,000	190,000	Y3	220,000	30,000	190,000
Y4	197,000	0	197,000	Y4	173,000	0	173,000
Y5	205,000	36,000	169,000	Y5	205,000	44,000	161,000
Y6	197,000	0	197,000	Y6	197,000	0	197,000
Y7	100,000	30,000	70,000	Y7	100,000	30,000	70,000
		NPV excluding investment	341,256.79			NPV excluding investment	350,804.71
		NPV including investment	122,256.79			NPV including investment	139,804.71

Based on the NPV we have just calculated, the 3T company should Fund the Alpha project as it offers the higher NPV

Dear Student,
Please ask, if you have any doubts through the comment section. Do rate the answer.