Re: ::: vuaskari.com ::: FIN622 assignment discussion

fin622 solution

Question No. 1

Calculate the Net Present Value and Profitability Index for each project.

Year	Project Alpha Rs.(000)	Project Beta Rs.(000)
0	(200,000)	(200,000)
1	60,000	55,000
2	80,000	65,000
3	75,000	70,000
4	60,000	80,000

Ans:   

Present value of Project Alpha.

As we know that

NPV=Sum of Net Cash Flows from each future year – Initial investment

In the preset question we have 4 years cash flows so we will calculate one by one as…

PV (CF1) =  =  = 53,428.317

PV (CF2) =  =80,000/ (1.123^2) = 63,435.224

PV (CF2) =  = 75,000/ (1.123^3) = 52,956.832

PV (CF2) =  = 60,000/ (1.123^4) = 37,725.259

TOTAL CASH FLOWS = 2, 07,545.632                  Now,

 

NPV=Sum of Net Cash Flows from each future year – Initial investment

NPV= 2, 07,545.632 – 200,000

NPV= 7545.632 or 7546        in positive

 

Present value of Project Beta.

 

PV (CF1) =  =  = 48,975.957

PV (CF2) =  =65,000/ (1.123^2) = 51,541.119

PV (CF2) =  = 70,000/ (1.123^3) = 49,426.376

PV (CF2) =  = 80,000/ (1.123^4) = 50,300.345

TOTAL CASH FLOWS = 200,243.797                    Now,

 

NPV=Sum of Net Cash Flows from each future year – Initial investment

NPV= 200243.797 – 200,000

NPV= 243.797 or 244            in positive

 

 

Profitability Index of Project Alpha

 

TOTAL CASH FLOWS = 2, 07,545.632

 

Profitability Index = PV of future cash flows / Initial investment

Profitability Index = 2, 07,545.632/ 200,000

Profitability Index = 0.00273

 

Profitability Index of Project Beta

 

TOTAL CASH FLOWS = 200,243.797

 

Profitability Index = PV of future cash flows / Initial investment

Profitability Index = 200,243.797 / 200,000

Profitability Index = 0.00122

 

Question No. 2

If you apply NPV criterion, which project should be selected and why? (1 mark)

Ans:

Alpha project should be accepted within NPV. Because of the following decision Rule of selecting Project within NPV is…

 

Ø      If the NPV of the project is more than zero, it should be accepted.

Ø      If 2 or more than 2 projects under contemplation, then the one with the higher NPV, should be accepted.

Ø      If the PV of future cash flows is greater than the initial investment, than it is positive.

Ø      If the PV of future cash flows is smaller than the initial investment, than it is better to scrap down the project.

Thus, alpha project has 7546 NPV while Beta project 244.

Question No. 3

If you apply Profitability Index criterion, which project should be selected and why? (1mark)

Ans:

Alpha project should be accepted within PI. Because of the following decision Rule of selecting Project within PI is…

 

Ø      The project which have a profitability index ration of more than one (PI>=1.0) are considered acceptable.

Ø      The project which have a profitability index ration of more than one (PI<1.0) are considered reject.

Ø      The project which is acceptable in NPV, also acceptable in PI.

Although, alpha project has not ration of 1 or grater than 1 but NPV is selection alpha project, than PI will also select alpha project.

 

Question No. 4

If you apply IRR criterion, which project should be selected and why? (2 marks)

Ans.

The IRR of Alpha Project= 14%

The IRR of Beta Project=12%

So, Alpha project with higher IRR will be acceptable because of having higher IRR and having higher than company's cost of capital.

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