Question 2 CI, K1 125marksl Synergy Industries is expanding its product line and

Question

Question 2 CI, K1 125marksl Synergy Industries is expanding its product line and its production capacity. The costs and expected cash flows of the two independent projects are given in the following table. The firm typically uses a discount rate of 15 percent. 1 25 marks | A) - $317,00o $27,70o $56,00o $55,00o $399,0oo $26,5oo $9,057 $10,536 $11,849 $13,814 2 4 1. Calculate the NPV of both the projects. 2. Calculate the IRR 3. Calculate the Profitability index 4. Should both projects be accepted? Or either? Or neither? Explain your reasoning

Explanation / Answer

(a).

NPV of project – A;

Years

Cash flow

Discount Factor @ 15%

Present value

0

- $317000

---

- $317000

1

$27700

1.15

24086.96

2

$56000

(1.15)2

42344.04

3

$55000

(1.15)3

36163.39

4

$399000

(1.15)4

228129.54

Net present value

13724 (Approx.)

NPV of project – B;

Years

Cash flow

Discount Factor @ 15%

Present value

0

- $26500

---

- $26500

1

$9057

1.15

7875.65

2

$10536

(1.15)2

7966.73

3

$11849

(1.15)3

7790.91

4

$13814

(1.15)4

7898.20

Net present value

5031 (Approx.)

(b).

IRR of project – A;

IRR of project A will be 16.438% (Approx.).

As we know that IRR refers to that rate of discount at which present value of future cash inflows will be equal to initial investment. Hence NPV must be zero.

Let’s check it with the help of following calculation;

Years

Cash flow

Discount Factor @ 16.438%

Present value

0

- $317000

---

- $317000

1

$27700

1.16438

23789.48

2

$56000

(1.16438)2

41304.38

3

$55000

(1.16438)3

34840.03

4

$399000

(1.16438)4

217067.07

Net present value

Nil (Approx.)

IRR of project – B;

IRR of project B will be 23.442% (Approx.).

As we know that IRR refers to that rate of discount at which present value of future cash inflows will be equal to initial investment. Hence NPV must be zero.

Let’s check it with the help of following calculation;

Years

Cash flow

Discount Factor @ 23.442%

Present value

0

- $26500

---

- $26500

1

$9057

1.23442

7337.05

2

$10536

(1.23442)2

6914.33

3

$11849

(1.23442)3

6299.31

4

$13814

(1.23442)4

5949.32

Net present value

Nil (Approx.)

(C).

Profitability index of project – A;

Formula of profitability index is as follow;

1 + (Net present value of future cash flows / Initial investment)

Now let’s put the values in the formula;

1 + ($13724 / $317000)

= 1.043 (Approx.)

Profitability index of project – B;

Formula of profitability index is as follow;

1 + (Net present value of future cash flows / Initial investment)

Now let’s put the values in the formula;

1 + ($5031 / $36500)

= 1.19 (Approx.)

(d).

Both projects should be accepted due to following reasons;

1. Both projects shows positive NPV thus it is a symbol of positive net cash flow in future time.

2. Both project have higher IRR in compare to basic discount rate of 15% hence both projects should be accepted.

3. Profitability index of both projects also more than 1 hence it shows that both projects will be profitable for the firm.

Years

Cash flow

Discount Factor @ 15%

Present value

0

- $317000

---

- $317000

1

$27700

1.15

24086.96

2

$56000

(1.15)2

42344.04

3

$55000

(1.15)3

36163.39

4

$399000

(1.15)4

228129.54

Net present value

13724 (Approx.)

Related Questions

Navigate

• Browse (All)
• Browse Q
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.