Use Table 1 to answer the following questions: (a) Using the Net Present Value m
ID: 2720663 • Letter: U
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Use Table 1 to answer the following questions: (a) Using the Net Present Value method, which of the two projects will you recommend for implementation? (b) Using the Rate of Return method, which of the two projects will you recommend? (c) Using the Benefit-Cost Ratio method, which of the two projects will you recommend? Please show your calculations and state your reasons for all three scenarios. Table 1: Life-Cycle Analysis Data
Project A Project B Capital cost = $10,000,000 Capital cost = $9,000,000 Annual Operating and Maintenance cost = $500,000 Annual Operating and Maintenance cost = $350,000 Reduction in annual user cost = $5,000,000 Reduction in annual user cost = $4,000,000 Project Life = 30 years Project life = 25 years Discount rate = 4% Discount rate = 5% Salvage value = $3,500,000 Salvage value = $3,000,000Explanation / Answer
NPV for even cash flows = R x {[1 – (1+i)-n]/i} – Initial Investment + Salvage Value
R is the net cash inflow expected to be received in each period;
i is the required rate of return per period;
n are the number of periods during which the project is expected to operate and generate cash inflows.
NPV of Project A:
Initial Investment = $10,000,000
R = $5,000,000 - $500,000 = $4,500,000
NPV = $4,500,000 x {[1 – (1+0.04)-30]/0.04} - $10,000,000 + 3,500,000 = $ 71,314,149.85
NPV of Project B:
Initial Investment = $9,000,000
R = $4,000,000 - $350,000 = $3,650,000
$3,650,000 x {[1 – (1+0.05)-25]/0.05} - $9,000,000 + 3,000,000 = $45,442,897.67
Based on NPV, Project A should be selected.
IRR for project A:
0 = -$10,000,000 + [($4,500,000)/(IRR)] + [($4,500,000)/(IRR)2] + [($4,500,000)/(IRR)3]…….+ [($4,500,000 + $3,500,000)/(IRR)30] = 45%
IRR for project B:
0 = -$9,000,000 + [($3,650,000)/(IRR)] + [($3,650,000)/(IRR)2] + [($3,650,000)/(IRR)3]…….+ [($6,650,000 + $3,500,000)/(IRR)30] = 40.55%
IRR method also suggests for Project A.
Benefit-cost Ratio for Project A:
Total Benefits = ($4,500,000*30) = $135,000,000
Total Cost = $10,000,000
Ratio = $135,000,000/$10,000,000 = 13.15
Benefit-cost Ratio for Project B:
Total Benefits = ($3,650,000*25) = $94,250,000
Total Cost = $9,000,000
Ratio = $135,000,000/$10,000,000 = 10.47
This also suggests that Project A should be opted.
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