FIN622 - Corporate Finance # 1 Assignment Solution

Semester “Spring 2010”

“Corporate Finance (Fin622)”

Assignment No. 1 Marks: 20

Being the finance manager of XYZ Company, you are to select one project of two available options i.e. Project A and Project B. The relevant cash flows for both the projects are summarized in given table.

Project A

Project B

Initial investment

Rs. 57,000

Rs. 54,000

Year(n)

Cash inflows (CFn)

Cash inflows (CFn)

1

Rs. 20,000

Rs. 22,000

2

20,000

20,000

3

20,000

18,000

4

20,000

16,000

Assume the discount rate to be 14 percent.

Required:

• Calculate the payback period of each project.

• Calculate the Net present value (NPV) of each project.

• On the basis of results of pay back period and NPV, which project would you recommend to your company and why?

Semester “Spring 2010”

“Corporate Finance (Fin622)” Assignment No. 1 Marks: 20

Q.1: Calculate the payback period of each project.

For Project A

Year	0	1	2	3	4
Project A	-57,000	20,000	20,000	20,000	20,000

The formula of Payback period is,

PP=Io/Ct

PP=57,000/20,000

PP=2.85years

For Project B

Year	0	1	2	3	4
Project B	-54000	22,000	20,000	18,000	16,000

Payback period is lies between year 2 and year 3 .Sum of money recovered by the end of the second year

= (22,000+20,000)

= 42,000

=54,000 – 42000

= 12,000

PP= (2+12,000/18,000)

PP=2.67years

Q.2: Calculate the Net present value (NPV) of each project.

For Project A

Year	0	1	2	3	4
Project A	-57,000	20,000	20,000	20,000	20,000

NPV=Cf [(1/i-1/i (1+i)]-Ct

NPV=20,000[(1/.14 - 1/.14 (1+.14) ^4)]-57,000

NPV=20,000[(7.1429 – 1/ 0.2365)] – 57,000

NPV=20,000 (7.1429 – 4.2283) – 57,000

NPV= 20,000 *(2.9146) – 57000

NPV=58291 – 57,000

NPV=1291

For Project B

Year	0	1	2	3	4
Project B	-54000	22,000	20,000	18,000	16,000

NPV= [Cf1/ (1+i) + Cf2/ (1+i) ^2+ Cf3/ (1+i) ^3+ Cf4/ (1+i) ^4] -Ct

NPV= [22,000 / (1+.14) +20,000/ (1+.14) ^2+18,000/ (1+.14) ^3+16,000 / (1+.14) ^4] - 54000

NPV=19298+15389+12150+9473-54000

NPV=56310 – 54000

NPV=2310

Q.3: On the basis of results of pay back period and NPV, which project would you recommend to your company and why?

As per the Calculation According to the Payback Period method we should have to take Project B Because it has less payback time as compare to Project A.

As far as the NPV is concern the both the projects is NPV > 0, so both Project could be possible to take , but the Project are Mutually exclusive then we should take the project that has the Greater NPV so that is the Project B.