Fin622 GDB Solution

Semester "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.

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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?

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After discounting all cash flows of projects with its opportunity coats, the net present
values of all three projects are (NPV)
Project A_NPV: +1432
Project B_NPV: -12200
Project C_NPV: +21485

1: On the basis of NPV approach, which project(s) you would select if the projects are independent and why?
ANS _1 :If the projects are independent so the projects that have +NPV should be accepted in the given scenario project A and C have positive NPV

2: On the basis of NPV approach, which project(s) you would select if the projects are mutually exclusive and why
Mutually exclusives are those projects where we have to choose only one out of different options.
If the projects are mutually exclusive the one with higher positive net present value (+NPV) should be chosen

Ans_2: So in given scenario the best project is C with the higher positive npv 21485 among three projects so rationally chose project C

Reference: Financial Management Theory and Practice 8th edition _BRIGHAM AND GAPENCSKI
Chapter #9 page #398

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Project A: NPV: 1432.64 Project B: NPV: -12200 Project C: NPV: 21485 On the basis of NPV approach, which project(s) you would select if the projects are independent and why? Ans: I will select project C first and after select project A on second because both have positive NPV. On the basis of NPV approach, which project(s) you would select if the projects are mutually exclusive and why? Ans In mutually exclusive I will select project C because it has positive NPV and also have larger amount 21485.

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Solution:

I.                    On the basis of NPV approach, which project(s) you would select if the projects are independent and why?

Ans :

First Project C will be selected and then project A will be selected as both have positive NPV.

II.                 On the basis of NPV approach, which project(s) you would select if the projects are mutually exclusive and why?

Ans :

In case of mutually exclusive, only Project C will be selected because it has positive and higher NPV value i-e 21485

 

Calculations:

 NPV net present value

I , initial investment = 45000

R , rate = 14% = 14/100= 0.14

t , time in years

CF = cash inflows

Project A :

I , initial investment = 45000

NPV = - I0 + CF1 / (1+r)t + CF2 / (1+r)t + CF3 / (1+r)t

         = -45000 + 20000/ (1+ 0.14) 1 + 20000 / (1+0.14) 2 + 20000/ (1+0.14)3

        = 1432.64 ( positive NPV)

Project B :

I , initial investment = 70000

NPV = - I0 + CF1 / (1+r)t + CF2 / (1+r)t + CF3 / (1+r)t

         = -70000 + 70000/ (1+ 0.14) 1 + 70000 / (1+0.14) 2 + 70000/ (1+0.14)3

        = -12200 ( negative NPV)

Project C:

I , initial investment = 50000

NPV = - I0 + CF1 / (1+r)t + CF2 / (1+r)t + CF3 / (1+r)t

         = -50000 + 50000/ (1+ 0.14) 1 + 50000 / (1+0.14) 2 + 50000/ (1+0.14)3

        = 21485 ( positive NPV)