Ques. 4 Synergy Industries is expanding its product line and its production capa

Question

Ques. 4 Synergy Industries is expanding its product line and its production capacity. The costs and expected cash flows of the two independent projects are given in the following table. The firm typically uses a discount rate of 16.4 percent. Calculate the NPV of both the projects. Should both projects be accepted? Or either? Or neither? Explain your reasoning. a. (4 marks) b. (4 marks) Product Line Expansion S(2,575,000) $600,000 $875,000 $875,000 $875,000 $875,000 Production Capacity Expansion S(8,137,250) $2,500,000 $2,500,000 $2,500,000 S3,250,000 $3,250,000 Year 4

Explanation / Answer

NPV : Net Present Value is used to calculate the present value of future cash inflows. It is calculated using the formula as

NPV = cash flows for period 1/(1 + R)1) + (Cash flows at Year 2 / (1 + R)2) ... (Cashflows at year x / (1 + R)x) - Initial Investment

Step 1: Calculate NPV for Product Line Expansion

Initial investment = 2 575 000

Present value of future cash inflows

= 600000/(1+0.164)1 +875000/(1+0.164)2  +875000/(1+0.164)3 +875000/(1+0.164)4+875000/(1+0.164)5 - Initial investment

= 2602222.17105 - 2 575 000 = 27222.17105

NPV is positive. So We can accept the project.

2) Product Capacity expansion initial investment = 8 137 250

Present value of future cash inflows

= 2500000/(1+0.164)1 +2500000/(1+0.164)2  +2500000/(1+0.164)3 +3250000/(1+0.164)4+3250000/(1+0.164)5 - Initial investment = 8869477.95245 - 8 137 250 = 732227.95245

Both projects can be accepted because if the NPV value is positive. In this problem, both projects shows positive value of NPV. Therefore both can be accepted.

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