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Thread: FIN622 Solution May 11,2010

  1. #1
    Senior Member viki's Avatar
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    Post 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.
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  2. #2
    Senior Member Guru's Avatar
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    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

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