Question
Submitted by Mio on Fri, 06/15/2012 - 12:18
I encountered a folowing question:
A company has to make a choice between two projects, because the available resources in money and kind are not sufficient to run both at the same time. Each project would take 9 months and would cost $250,000.
- The first project is a process optimization which would result in a cost reduction of $120,000 per year. This benefit would be achieved immediately after the end of the project.
- The second project would be the development of a new product which could produce the following net profits after the end of the project:
|
1. year: |
$ |
15,000 |
|
2. year: |
$ |
125,000 |
|
3. year: |
$ |
220,000 |
Assumed is a discount rate of 5% per year. Looking at the present values of the benefits of these projects in the first 3 years, what is true?
|
Both projects are equally attractive. |
|
The first project is more attractive by app. 7%. |
|
The second project is more attractive by app. 5%. |
|
The first project is more attractive by app. 3%. |
How to calculate these type of questions please?
Forums:
amitkuiya
Fri, 06/15/2012 - 16:35
Permalink
C
Looks its longer to calculate
Project 1
Assuming 5% NPV rate annually we can assume discounting factors as 0.95, 0.90 and .85 respectively for next three years
120,000 * 0.95 = 114000
120,000 * 0.90 = 108000
120,000 * 0.85 = 102000
Total = 324000
Project2:
Same way returns will be
14250
112500
187000
Total: 313750
Difference : (324000-313750) / 313750 ~= 3% (after X 100)
sspawar
Sat, 06/16/2012 - 13:32
Permalink
EXACT LY AS PER FORMULAE
www.financeformulas.net/Formula%20Images/Present%20Value%201.gif
HERE r = .05, n = 1, 2 , 3
pv1 = 120000/(1+0.05)^1 +120000/(1+0.05)^2+120000/(1+0.05)^3
pv2 = 15000/(1+0.05)^1+125000/(1+0.05)^2+220000/(1+0.05)^3
pv1> pv2
hence (pv1-pv2/pv2 )*100 = 2.8595%
and NPV will be total inflow - total out flow
(NPV1-NPV2/NPV2) *100 = 13.41%