Question

A company is considering to choose between two investment projects with the

following details.
Project A : Costs RM7 million in upfront costs and will generate RM3 million in
annual income for five years starting three years from now.
Project B : Costs RM2.5 million upfront and RM2 million in each of the next
three years. This project generates no annual income but will be sold
six years from now for a sales price of RM16 million.
By using Net Present Value approach, with a discount rate of 8%, determine
which project should be choosen by the company.​

Answer 1

Answer: Project A should be chosen as it has the highest NPV.

Explanation:

Project A

Present value of inflows:

First find the present value of inflows 3 years from today. Bear in mind that the inflow is constant so this is an annuity:

= 3 million * Present value interest factor of annuity, 8%, 5 years

= 3 million * 3.9927

= RM11,978,100

Discount this value to the present:

= 11,978,100 / (1 + 8%)³

= RM9,508,602

Net Present value = Present value of inflows - Investment

= 9,508,601 - 7,000,000

= RM2,508,601

Project B:

Find present value of costs:

= 2,500,000 + (2 million * Present value interest factor of annuity, 3 years, 8%)

= 2,500,000 + (2,000,000 * 2.5771)

= 2,500,000 + 5,154,200

= RM7,654,200

Net present value = (16,000,000 / (1 + 8%)⁶) - 7,654,200

= RM2,428,514

Project A should be chosen as it has the highest NPV.