From the following information, calculate the net present value of the two proje
ID: 2772289 • Letter: F
Question
From the following information, calculate the net present value of the two projects and suggest which of the two projects should be accepted a discount rate of the two.
Project X
Project Y
Initial Investment
Rs. 20,000
Rs. 30,000
Estimated Life
5 years
5 years
Scrap Value
Rs. 1,000
Rs. 2,000
The profits before depreciation and after taxation (cash flows) are as follows:
Year 1
Year 2
Year 3
Year 4
Year 5
Rs.
Rs.
Rs.
Rs.
Rs.
Project X
5000
10,000
10,000
3000
2000
Project Y
20000
10,000
5000
3000
2000
Note: The following are the present value factors @ 10% p.a.
Year
1
2
3
4
5
6
Factor
0.909
0.826
0.751
0.683
0.621
0.564
Project X
Project Y
Initial Investment
Rs. 20,000
Rs. 30,000
Estimated Life
5 years
5 years
Scrap Value
Rs. 1,000
Rs. 2,000
Explanation / Answer
It is a problerm on capital budget. In such projects you have to make long term investment. You will get return of cash flows for more than a year. Here two projects are mentioned. You have to select the best one. You have to apply capital budgeting technique to get the best one.
Different methods of evaluating capital investment projects are available. Among them Net present value is the best one. Here you have to apply this method to get the decisio. Steps are as as follows.
1. First calculate cash flows of different years. Here it is the sum of cash flow before depreciation and tax plus scrap value received at theend of the life of the project. Note that tax rate are not mentioned. So tax shield enefit (tax saved) on depreciation amount is not considered. Otheerwise it will add to the cash flow.
2. Now calculate present value of cash flows by multiplying them by the discounting facors.
3. Add present value of cash flows of different years to get total present value of cash flows. It is known as gross present value.
4. Deduct initial csh outflow from gross present value to get net present value (NPV)
5. Finally compare the NPV of the two alternatives. Select the project with highest NPV.
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In this problem you have two projects of 5 years life, using the available data their NPVs are estimated below:
Result: Compare NPV of project 1 and project 2. As the NPV of project 2 is highest, it will be accepted.
Statement showing present value of cash flows from the Project1 Details Years 1 2 3 4 5 Total 1 Cash flow before depreciation & tax $5,000 $10,000 $10,000 $3,000 $2,000 $30,000 2 Add: Scrap value $1,000 $1,000 3 Total scrap value $5,000 $10,000 $10,000 $3,000 $3,000 $31,000 4 Present value factor at 10% 0.909 0.826 0.751 0.683 0.621 5 Present value $4,545 $8,260 $7,510 $2,049 $1,863 $24,227 6 Less: Initial investment $20,000 7 Net present value (NPV) $4,227 Statement showing present value of cash flows from the Project 2 Details Years 1 2 3 4 5 Total 1 Cash flow before depreciation & tax $20,000 $10,000 $5,000 $3,000 $2,000 $40,000 2 Add: Scrap value $2,000 $2,000 3 Total scrap value $20,000 $10,000 $5,000 $3,000 $4,000 $42,000 4 Present value factor at 10% 0.909 0.826 0.751 0.683 0.621 5 Present value $18,182 $8,260 $3,755 $2,049 $2,484 $34,730 6 Less: Initial investment $30,000 7 Net present value (NPV) $4,730Related Questions
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