FIN2001 FINANCIAL MANAGEMENT

Home Assignment 4 (Topic 8 & 9)

Q1 Two mutually exclusive projects

Cost of Capital: 10%
YEAR CASHFLOW (X) DISCOUNTED CASHFLOW (X) CASHFLOW (Y)
0 $ (42,500) $ (42,500) $ (34,000)
1 $ 28,000 $ 25,455 $ 6,500
2 $ 16,500 $ 13,636 $ 14,000
3 $ 6,600 $ 4,959 $ 24,400
NPV $ 1,550
IRR 12.61%

Part A: Payback period for each project

Project X 1.88 years

Project Y 2.55 years

Part B: NPV of each project

Project X $ 1,549.59
Project Y $ 1,811.42

Part C: Conclusions

Answer: Both projects are mutually exclusive, so we can select only one project. Both projects have positive NPVs, with IRR g
Payback period of project X is lower than that of the Project Y, mainly because project X is generating higher cashflow
So, as per the NPV criterion, Project Y will be choosen due to its higher positive NPV because NPV is more realistic ap
NPV method is preferable because IRR is unreliable in case of mutully exlcusive cases like this and with non-conventi
Decision: Project Y will be choosen due to higher positive NPV of $1,811
 DISCOUNTED CASHFLOW (X)
$ (34,000)
$ 5,909
$ 11,570
$ 18,332
$ 1,811
12.47%

ojects have positive NPVs, with IRR greater than its cost of capital i.e., 10%
project X is generating higher cashflows in the later years not in the earlier years like Project X.
NPV because NPV is more realistic approach in determining the future feasibility of a project
cases like this and with non-conventional cashflows.
Q2:
Data:
Initial fixed investment cost: $4.2 million
Years 3 years
Depreciation method Striaght line
Initial investment in NWC $420,000
Annual Sales $3,500,000
Annual cost of sales $1,680,000
Tax rate 20%
Required return 10%

Solution:

Part A:
Operating cash flow (OCF): EBIT+Depreciation-Taxes

PROJECTED INCOME STATEMENT

Annual Savings (Sales-Cost) $1,820,000

Depreciation per year $1,400,000
PBT $420,000
Tax rate 20%
Tax $84,000
Net Income $336,000
OCF (Net Income+Depreciation) $1,736,000

Part B:
Net cashflows for 0-3 years

Total Initial Investment: Fixed Investment cost + NWC

Total Initial Investment: $4,620,000

Year 0 Year 1 Year 2 Year 3

Annual Savings $1,820,000 $1,820,000 $1,820,000
Depreciation cost 1400000 1400000 1400000
PBT $420,000 $420,000 $420,000
Tax cost (@20%) $84,000 $84,000 $84,000
Net Income $336,000 $336,000 $336,000
OCF $1,736,000 $1,736,000 $1,736,000
Terminal Cash flow $420,000

Net Cashflow ($4,620,000) $1,736,000 $1,736,000 $2,156,000

Part C:
Project's NPV and conclusion
 Net Cashflow Discounted Cashflows @ 10%
Year 0 ($4,620,000) ($4,620,000)
Year 1 $1,736,000 $1,578,182
Year 2 $1,736,000 $1,434,711
Year 3 $2,156,000 $1,619,835

NPV $12,727

Conclusion for this project: This project should be accepted as it is bringing higher positive cashflows (NPV) of $12,727 to
shflows (NPV) of $12,727 to the company and will generate above average returns