You are a CEO of Daniel Thomas Inc. Your manager, Ali, comes to you with two alt

Question

You are a CEO of Daniel Thomas Inc. Your manager, Ali, comes to you with two alternate proposals, named: GrowthProject and NonGrowthProject. If you select GrowthProject, you expect to receive the first cash flow of $50,000 at the end of year three; there after cash flow would increase by 2% over the next years, in perpetuity. On the other hand, if you choose NoGrowthProject, then you would start getting first cash flow of $55,000 at the end of year, and subsequently over the next years, in perpetuity.

Ali argues that as GrowthProject is more risky compared to NonGrowthProject, your required rate of return of GrowthProject should be higher than the same of NonGrowthProject. If the required rate of returns for the GrowthProject and NonGrowthProject are respectively 10% and 9%, then:

A) Calculate the PV of GrowthProject and NonGrowthProject                                   

B) As a CEO, which project you should select, based your calculations

Explanation / Answer

A. NPV of Growth project = 50,000 x PVF(10%, 3 year) + 51,000/(0.10 - 0.02) x PVF(10%, 4 year) = $472,986.82

NPV of Non-Growth Project = 55,000/0.09 x PVF(9%, 1 year) = $560,652.40

B. Since the NPV of Non-Growth project is high we should select the Non-Growth project.

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