Financial Management

06. Time Value of Money and Valuation

Question: Siddhartha Ltd. can manufacture two different new products at
their plant. Product 1 is expected to earn no profit in the first year, 1,500 in
the second year and 2,500 in the third year.
Product 2 is expected to earn 1,000 in the first year, 2,000 in the second
year and 1,000 in the third year. Assume the cost of capital is 10%. Decide
which product should be manufactured.

Solution:

Yea
r
1
2
3

Cash Inflows ()
Produc
t1
1,500
2,500

Produc
t2
1,000
2,000
1,000

Present
Value
Factor* @
10%
0.909
0.826
0.751
Total

Present Value of
Cash Inflows**
()
Produc Produc
t1
t2
909
1,239
1,652
1,878
751
3,117
3,312

Conclusion:
As NPV of Product 2 is more than that of Product 1, the company should
manufacture Product 2.