Question

Assume that your firm wants to choose between two project options:

Project A: Br. 500,000 invested today will yield an expected income stream of Br150, 000 per year for 5 years, starting in Year 1.
Project B: an initial investment of Br 400,000 is expected to produce this revenue stream: Year 1 = 0, Year 2 = Br 50,000, Year 3 = Br 200,000, Year 4 = Br300, 000, and Year 5 = Br200, 000. Assume that a required rate of return for your company is 10% and that inflation is expected to remain steady at 3% for the life of the project. Which is the better investment? Why?

Answer 1

Project B should be the better investment

Step-by-step explanation:

The computation is shown below;

Project A Cash Flow Discount Factor New Inflows

(Present Value)

Year

0 ($500,000) 1.000 ($500,000)

1 $150,000 0.885 $132,743

2 $150,000 0.783 $117,472

3 $150,000 0.693 $103,958

4 $150,000 0.613 $91,998

5 $150,000 0.543 $81,414

NPV Total $27,585

Project B Cash Flow Discount Factor New Inflows

(Present Value)

Year

0 ($400,000) 1.000 ($400,000)

1 $0 0.885 $0

2 $50,000 0.783 $39,157

3 $200,000 0.693 $138,610

4 $300,000 0.613 $183,996

5 $200,000 0.543 $108,552

NPV total $70,315

Based on the above calculations, the project B contains high net present value as compared with the project A so Project B should be the better investment