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. Your analysts predict that inflation rate will be a stable 3 percent over the next 7 years. Below is the cash flow infommation for each project. Which of the two projects would you fund if the decision is based only on financial information? Why? (Use NPV) Omega Alpha Inflow Year Outflow Netlow Year Inflow Outflow Netflow YO $225,000 -225 000 YO 0 $300,000 -300,000 190,000 -190.000 Y1 $50,000 YI 100,000 -50,000 Y2 $150,000 0 150.000 Y2 150,000 250.000 150,000 30,000 190,000 Y3 220.000 Y3 50,000 200,000 Y4 Y4 215,000 215.000 250,000 250,000 175.000 197.000 200.000 180,000 Y5 205,000 30,000 Y5 50,000 150,000 Y6 Y6 180.000 197.000 30.000 Y7 100.000 120,000 70.000 Y7 30,000 90.000 Total 1,087,000 505,000 582.000 Total 530,000 200.000 670.000

Answer 1

	A	B	C	D	E	F	G	H	I	J
1
2	Exercise 2.4a
3	Net Present Value Example Comparing Two Projects
4
5	Project Omega		Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7
6	Required Rate of Return	18%
7	Investment		-$225,000
8	Cash Inflows			-$190,000	$150,000	$190,000	$215,000	$175,000	$197,000	$70,000
9	NPV =	$119,689	Formula Project Omega: =C7+NPV(B6,D8:J8)
10
11	Project Alpha		Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7
12	Required Rate of Return	18%
13	Investment		-$300,000
14	Cash Inflows			-$50,000	$150,000	$200,000	$250,000	$150,000	$180,000	$90,000
15	NPV =	$176,525	Formula Project Alpha: =C13+NPV(B12,D14:J14)
16
17	NPV comparison: Accept both Omega and Alpha, or select Alpha that has the highest NPV of $176,525
18
19	Exercise 2.4b
20	Net Present Value Example Comparing Two Projects (with inflation)
21
22	Project Omega		Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7
23	Required Rate of Return	21%
24	Investment		-$225,000
25	Cash Inflows			-$190,000	$150,000	$190,000	$215,000	$175,000	$197,000	$70,000
26	NPV =	$76,650	Formula Project Omega: =C24+NPV(B23,D25:J25)
27
28	Project Alpha		Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7
29	Required Rate of Return	21%
30	Investment		-$300,000
31	Cash Inflows			-$50,000	$150,000	$200,000	$250,000	$150,000	$180,000	$90,000
32	NPV =	$129,536	Formula Project Alpha: =C30+NPV(B29,D31:J31)
33
34	NPV comparison: Accept both Omega and Alpha, or select Alpha that has the highest NPV of $129,536