Fin622 GDB No. 1 solution
Monday, November 22, 2010 Posted In Fin Edit ThisSemester "Fall 2010"
"Corporate Finance (Fin622)"
This is to inform that Graded Discussion Board (GDB) will be opened according to the following schedule
Schedule
Opening Date and Time
November 22 , 2010 At 12:01 A.M. (Mid-Night)
Closing Date and Time
November 24 , 2010 At 11:59 P.M. (Mid-Night)
Topic/Area for Discussion
" Capital budgeting"
Note: The discussion question will be from the area/topic mentioned above. So start learning about the topic now.
Discussion Question
XYZ Company is one of the biggest manufacturing concerns of the country. Being the finance manager of XYZ Company, you have been assigned a task to evaluate three projects. The future cash flows from the three projects are summarized in given table.
Project A
Project B
Project C
Initial investment
45,000
70,000
50,000
Cash inflows
Year 1
20,000
20,000
30,000
Year 2
20,000
26,000
28,000
Year 3
20,000
30,000
35,000
Consider the discount factor to be 14% and that the company has sufficient funds to take projects.
Required:
I. On the basis of NPV approach, which project(s) you would select if the projects are independent and why?
II. On the basis of NPV approach, which project(s) you would select if the projects are mutually exclusive and why?
Project B
Project C
Initial investment
45,000
70,000
50,000
Cash inflows
Year 1
20,000
20,000
30,000
Year 2
20,000
26,000
28,000
Year 3
20,000
30,000
35,000
Consider the discount factor to be 14% and that the company has sufficient funds to take projects.
Required:
I. On the basis of NPV approach, which project(s) you would select if the projects are independent and why?
II. On the basis of NPV approach, which project(s) you would select if the projects are mutually exclusive and why?
.........
FIN622 GDB No. 1 Solution
Project A
Initial Investment = 45000
Years 1 2 3
Cash Flows 20000 20000 20000
Calculation:-
NPV = -Io + CF1/(1+r)t + CF2/(1+r)t + CF3/(1+r)t
NPV = - 45000 + 20000/(1+0.14)1 + 20000/(1+0.14)2 + 20000/(1+0.14)3
NPV = -45000 + 17543.859 + 15389.350 + 13499.430
NPV = - 45000 + 46432.639
NPV = 1432.639
Project B
Initial Investment = 70000
Years 1 2 3
Cash Flows 20000 26000 30000
Calculation:-
NPV = -Io + CF1/(1+r)t + CF2/(1+r)t + CF3/(1+r)t
NPV = - 70000 + 20000/(1+0.14)1 + 26000/(1+0.14)2 + 30000/(1+0.14)3
NPV = - 70000 + 17543.859 + 20006.155 + 20249.145
NPV = - 70000 + 57800
NPV = - 12200
Project C
Initial Investment = 50000
Years 1 2 3
Cash Flows 30000 28000 35000
Calculation:-
NPV = -Io + CF1/(1+r)t + CF2/(1+r)t + CF3/(1+r)t
NPV = - 50000 + 30000/(1+0.14)1 + 28000/(1+0.14)2 + 35000/(1+0.14)3
NPV = - 50000 + 26316 + 21545 + 23624
NPV = - 50000 + 71485
NPV = 21485
1) On the basis of NPV approach, which project(s) you would select if the projects are independent and why?
Reference:
MGT201 (Page 47)
Independent: implies that the cash flows of the two investments are not linked to each other
Solution:-
If the projects are independent then I will select Project C 1st and after that I will select Project A on 2nd because both have Positive NPV.
2) On the basis of NPV approach, which project(s) you would select if the projects are mutually exclusive and why?
Reference:
MGT201 (page 47)
Mutually Exclusive: means that you can invest in ONE of the investment choices and having chosen one you cannot choose another.
Solution:-
I will Select Project C because it has positive NPV and also have greater amount Rs. 21485.
