Question

Marks = 30) Year 1 Year 2 evaluating the following two projects. The cost of SARBELLE LADIES CLUB Company has the chance to open a third brunch. There we toute Project A is AED 550.000, for Project B is AED 350,000. The cost of capital is 10%. Project A Year 3 120,000 Year 4 130,000 Year 5 Project B 145.000 100,000 150.000 165.000 110,000 120,000 140.000 150,000 1) Calculate the net present value (NPV) of the two projects, A and B. 2) Indicate which project the company should accept and why. 6 Page

Answer 1

1. Calculation of NPV

Final Answer

Particular	Project A	Project B
NPV	– AED19, 639 (Negative NPV)	AED 110,725

Workings

NPV = Present Value of future cash inflows – Initial Investment

Project A – Calculation of NPV

Initial Investment = AED 550,000

Present Value of future cash inflow

Year	Cash Flows In AED	Present value factor @ 10%	Present Value
(I)	(II)	(III)	(II) * (III)
1	AED 120,000	0.9091	AED 109,092.00
2	AED 130,000	0.8264	AED 107,432.00
3	AED 145,000	0.7513	AED 108,938.50
4	AED 150,000	0.6830	AED 102,450.00
5	AED 165,000	0.6209	AED 102,448.50
Present Value of the future Cash inflows			AED 530,361.00

NPV of project A = AED 530,361 – AED 550,000

                        = (AED 19,639)

NPV is Negative i.e. – AED19, 639/-

Project B – Calculation of NPV

Initial Investment = AED 350,000

Present Value of future cash inflow

Year	Cash Flows In AED	Present value factor @ 10%	Present Value
(I)	(II)	(III)	(II) * (III)
1	AED 100,000	0.9091	AED 90,910.00
2	AED 110,000	0.8264	AED 90,904.00
3	AED 120,000	0.7513	AED 90,156.00
4	AED 140,000	0.6830	AED 95,620.00
5	AED 150,000	0.6209	AED 93,135.00
Present Value of the future Cash inflows			AED 460,725.00

NPV of project A = AED 460,725 – AED 350,000

                        = AED 110,725

NPV is Positive

Answer For Part 2

2. Since project B is having positive NPV, Project B should be selected.

Explanations for selection

The NPV method provides straightforward criteria for choosing or rejecting investment projects.

Projects with positive NPVs qualify for selection because their benefits, in terms of target returns exceed costs.

Investments yield zero NPV when they have equal benefits and costs.

Negative NPVs, on the other hand, are loss-making investments that must be rejected.

Note:

Calculation of Present value Factor

Discount Factor = 1/ (1+R) ^N

R = Discount Rate (i.e. = 10%)

N = No of years

E.g. for year 2 Discount Factor = 1/ (1.10)²

                                                                ⁼ 1/ (1.10) (1.10)

                                                = 0.8264