A few small projects could be funded and the decision to be made is which should

Question

A few small projects could be funded and the decision to be made is which should get the money. Rangi has been granted the use of $15,000 for a maximum of two years. She is considering three projects. Project A costs $7,500 and has cash flows of $4,000 a year for Years 1 to 3. Project B costs $8,000 and has cash flows of $3,000, $4,000, and $3,000 for Years 1 to 3, respectively. Project C costs $2,000 and has a cash inflow of $2,500 in Year 2.

a.       What decisions should she make regarding these projects if she assigns them a mandatory discount rate of 8.5 percent?

b.       Explain why your answers in a. above are correct.

c.       What is the difference between discounted payback and NPV approach? Demonstrate with an example.

Explanation / Answer

All projects will be evaluated using NPV Project A Year Cashflow Present value@8.5% Discounted cashflow 0 -7500 1 -7500 1 4000 0.9217 3686.6359 2 4000 0.8495 3397.8211 3 4000 0.7829 3131.6324 NPV 2716.089 Project B Year Cashflow Present value@8.5% Discounted cashflow 0 -8000 1 -8000 1 3000 0.9217 2764.9770 2 4000 0.8495 3397.8211 3 3000 0.7829 2348.7243 NPV 511.522 Project B Year Cashflow Present value@8.5% Discounted cashflow 0 -2000 1 -2000 1 0 0.9217 0.0000 2 2500 0.8495 2123.6382 3 0 0.7829 0.0000 NPV 123.638 Since all three projects have a positive NPV, all three projects can be accepted.

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