Challenge 3 (30 points) al net benefits (not including the investment) are given
ID: 2804270 • Letter: C
Question
Challenge 3 (30 points) al net benefits (not including the investment) are given. You are trying to decide if the annual net beehts are large enough to justify any ou have been asked to evaluate 4 projects. The NPV of the investment and the equivalent uniform annu ofthe inves tments. The minimum acceptable rate ofreturn for your firmis10%, Problem 7 Investment and Benefit Data for Four Projects NPV (Using al wo Investment (NPV as Equivalent Annual Net of time zero $1 milliorn $2 million $2.6 million $4 million method) Benefits $130,000 $190,000 $286,000 $480,000 IRR 13% 9.5% 11% | 12% Project Question 3.a. (10 points) Calculate the NPV for each project and fill in Table 1.1. In calculating the NPV, assume the annual net benefits continue forever, so that you can use the capital worth method. Question 3.b. (10 points) Assume that these projects are independent, so that the firm could carry out any or all of them. Which projects are justified using the NPV method? Which are justified using the IRR method? Question 3.c. (10 points) Assume that these projects are mutually exclusive alternatives for developing a specific site. Which project is best? Why? Projede: -¢h.nen.) A. A,Explanation / Answer
3A :- Net Present Value of the project = Present value of the cash Inflow - present value of the cash outflow
Project A :- (130,000/ 10%) - 1,000,000 { Since in the question the benefits are given for forever therefore to calculate it's present value we simpmly discount it with the minimum acceptable rate of return }
NPV = 300.000 ($)
Project B :- (190000/10%)-2000000 = -100,000 ($) {npv}
Project C :- (286000/10% ) - 2600000 = 260000 ($) {NPV}
Project D :- (480000/10%) - 4000000 = 800000 ($) {NPV}
3B :- Since in the given question the projects given are independent i.e. selection of one project is not dependent upon other porjects viability, therefore as per NPV and IRR we have to evaluate each project individually
as per NPV all projects except project B should be accepted as all other projects has positive NPV .
Now as per IRR approach those projects should be selected whose IRR is greater than minimum acceptable rate of return. ( also IRR is calculated by taking project NPV = 0 )
therefore all projects except project B should be accepted as project B IRR is less than 10%.
3C:- Now as per the question we have the given projects as mutually exclusive hence out of the given Projects one should be selected
First make it clear that among the two approaches NPV AND IRR, if both gives diferent results then NPV should be preferred,
hence in the given case as per NPV project D should be selected but as per IRR project A should be selected, Hence we will go with NPV and project D should be selected in a scenario of mutually exclusive projects.