question archive A company has the option of investing in Project A or Project B, but not both
A company has the option of investing in Project A or Project B, but not both
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A company has the option of investing in Project A or Project B, but not both. The company uses a discount rate of 14% and depreciates assets using the straight line method. Project A requires an initial investment of $70,000 and Project B requires an initial investment of £60,000. The equipment purchased for Project A would be disposed of at the end of year 5 with a $10,000 scrap value. The equipment purchased for Project B would be disposed of at the end of year 3 with a nil scrap value. The profit projections for the two projects (excluding the initial investments and scrap values) are: Year 1 2 3 4 5 Profit (6) Project A Project B 32.000 30.000 40,000 42.000 43,000 33,000 45,000 35,000 28.000 (a) Calculate the payback period for both projects. (15 marks) Calculate the NPV (Net Present Value) for both projects. See Table 2a. (25 marks) (b) (c) Advise the company on which project to accept (stating your reasons based on depreciation and profitability index). (10 marks) NPV/INITAL INVEST
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Year Project A DF @ 14% Present Value Cumulative Project B DF @ 14% Present Value Cumulative 0 -70000 1 -70000.00 -70000.00 -60000 1 -60000 -60000 1 32000 0.8772 28070.18 -38000.00 30000 0.8772 26315.78947 -30000 2 40000 0.7695 30778.70 2000.00 42000 0.7695 32317.6362 12000 3 43000 0.6750 29023.78 45000.00 33000 0.6750 22274.06003 45000 4 45000 0.5921 26643.61 90000.00 35000 0.5921 20722.80971 80000 5 28000 0.5194 14542.32 118000.00 5 10000 0.5194 5193.69 128000.00 i) NPV = Sum of all NPVs Less Initial Investment Project A 64252.27 Accepted as NPV is higher Project B 41630.3 Rejected as NPV is lower ii) Payback Project A 1.95 Rejected as Payback period is high Project B 1.71 Accepted as Payback period is low
