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# Thread: FIN622 Solution May 11,2010

1. ## FIN622 Solution May 11,2010

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Solution:
(i) Applying Capital Budgeting Techniques
a) Pay back period.
Project A Initial value = 57000

Years 1 2 3 4
Cash Flows(Rs.) 20000 20000 20000 20000
Cumulative CF 20000 40000 60000 80000
Payback Period for this project is somewhere between 2 and 3 years cost recovers in
between these years. At the end of year 2, Rs 40000 has been recovered and Rs 17000 are
to be covered from next years cash flow of Rs 20000.
Payback period = 2 + 17000/20000 = 2.85 years
Project B initial value = 54000
Years 1 2 3 4
Cash Flows(Rs.) 22000 20000 18000 16000
Cumulative CF 22000 42000 60000 76000
Payback Period for this project is somewhere between 2 and 3 years cost recovers in
between these years. At the end of year 2, Rs 42000 has been recovered and Rs 12000 are
to be covered from next years cash flow of Rs 18000.
Payback period = 2 + 12000/18000 = 2.67 years
Net Present Values
Project A = Discount Rate = 14%
NPV= -IO+_CFt/ (1+i) t
NPV= -IO+ CF1/ (1+i) 1 + CF2/ (1+i) 2 + CF3/ (1+i) 3 + CF4/ (1+i) 4
NPV= -57000+ 20000/ (1+0.14) 1 + 20000/ (1+0.14) 2 + 20000/ (1+0.14) 3 + 20000/
(1+0.14) 4
NPV= -57000+ 20000/ (1.14) 1 + 20000/ (1.14) 2 + 20000/ (1.14) 3 + 20000/ (1.14) 4
NPV= -57000+ 20000/ 1.14 + 20000/ 1.2996 + 20000/ 1.481544 + 20000/ 1.68896016
NPV= -57000+ 17544 + 15689 + 13500 + 11841
NPV= -57000 + 58574
NPV= 1574

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Project B = Discount Rate = 14%
NPV= -IO+_CFt/ (1+i) t
NPV= -IO+ CF1/ (1+i) 1 + CF2/ (1+i) 2 + CF3/ (1+i) 3 + CF4/ (1+i) 4
NPV= -54000+ 22000/ (1+0.14) 1 + 20000/ (1+0.14) 2 + 18000/ (1+0.14) 3 + 16000/
(1+0.14) 4
NPV= -54000+ 22000/ (1.14) 1 + 20000/ (1.14) 2 + 18000/ (1.14) 3 + 16000/ (1.14) 4
NPV= -54000+ 22000/ 1.14 + 20000/ 1.2996 + 18000/ 1.481544 + 16000/ 1.68896016
NPV= -54000+ 19298 + 15689 + 12150 + 9473
NPV= -54000 + 56610
NPV= 2610
Decision:
Project A = 1574 NPV
Project B = 2610 NPV
According to the NPV of both projects, I will recommend project B due to greater NPV
of project B from A.
Project A = 2.85 years Payback Period
Project B = 2.667 years Payback Period
According to the Payback period of both projects, I will also recommend Project B,
because in Project B the payback period (PP) is little than Project A.  Reply With Quote

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3. SOLUTION

1) The payback period of each project

THE PAYBACK PERIOD (PP); For the Project A that has equal receipts

= Initial Investment / Cash Flow (I0/Ct)

= 57000/20000

= 2.85year

THE PAYBACK PERIOD (PP); For the Project B

Payback period lie between 2nd year and 3rd year

Sum of the money recovered by the end of second year

= (22000+20000)

= 42000

Sum of money recovered by the end of 3rd year

= (54000  42000)

= 12000

= [2+ 12000/18000) years

= 2.667 years

2) The Net present value (NPV) of each project.

NPV for project A;

Formula:

(CFn * PVFA at 14% for 4 years)  Initial Investment

PVFA at 14% for 4 years:

= [1/ (1+i) ^ n + 1/ (1+i) ^ n + 1/ (1+i) ^ n + 1/ (1+i) ^ n]

= [1/ (1+0.14) ^1 + 1/ (1+0.14) ^2 + 1/ (1+0.14) ^3 + 1/ (1+0.14) ^4]

= [0.8772 + 0.7695 + 0.6749 + 0.5920]

= [2.9136]

By putting values in Formula:

= (20000 * 2.9136)  57000

= 1272

NPV for project B;

Formula:

Sum of the NPV (CFn)  Initial investment

Sum of the NPV (CFn)

= [CF1/ (1+i) ^ n + CF2/ (1+i) ^ n + CF3/ (1+i) ^ n + CF4/ (1+i) ^ n]

= [22000/ (1+0.14) ^1 + 20000/ (1+0.14) ^2 + 18000/ (1+0.14) ^3 + 16000/ (1+0.14) ^4]

= 19298.246 + 15389.352 + 12149.487 + 9473.284

= 56310.368

By putting values

= 56310.368  54000

= 2310.368

3) Decision

Solution.jpg  Reply With Quote

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