Question

Question 2: As managing director (MD) of a company, you need to make a decision on which project to fund from the four you are being presented with: | Year Project #1 Project #2 Project #3 Project #4 Investment £389k £388k £183k £529k Year 1 £121k £142k £231k £OK Year 2 £421k £222k £249k £553k Year 3 £1208k £404k £825k £1m Year 4 £Ok £881k £200k £548k Year 5 Ok £1.23m £112k £448k Calculate and show the derivation of the payback period for each project. Calculate and show the derivation of the NPV for each project (20% discount). • Write down the equation for the IRR, and obtain the IRR for each project. • Justify which project you would favour. [50 marks

Answer 1

						Amount in '000'
	Year	Investment	Year 1	Year 2	Year 3	Year 4	Year 5
	Project #1	£               389.00	£                          121.00	£                  421.00	£     120.00	£            -	£               -	£                      662.00
	Project #2	£               388.00	£                          142.00	£                  222.00	£     404.00	£ 881.00	£ 1,230.00	£                  2,879.00
	Project #3	£               183.00	£                          231.00	£                  249.00	£     825.00	£ 200.00	£     112.00	£                  1,617.00
	Project #4	£               529.00	£                                   -	£                  553.00	£ 1,000.00	£ 548.00	£     448.00	£                  2,549.00
1	Pay Back pd.	Annualized expected cash flow
		Initial Expenditure
	Project #1	1.701799486
	Project #2	7.420103093
	Project #3	8.836065574
	Project #4	4.81852552
2	NPV	Present value of future cash inflows discounted @20% - Initial expenditure
		(Present value discounted @ 20%)
	Project #1	73.63
	Project #2	1306.89
	Project #3	751.21
	Project #4	1936.05	Best
3	IRR	R1+	NPV1 X (R2-R1)
			NPV1 - NPV 2
	where:	R1​,R2​=randomly selected discount rates​
		NPV1​=higher net present value
		NPV2​=lower net present value
	Project #1	Let R1 = 10,
		R2 = 15
		NPV 1 = 159.09
		NPV 2 =113.45
		IRR =	10+	159.09X(15-10)
				159.09-113.45
				28.00%	Approx
	Project #2	Let R1 = 20
		R2 = 25
		NPV 1 = 1037.47
		NPV 2= 838.43
		IRR =	20+	1037.47X(25-20)
				1037.47-838.43
				46.00%	Approx
	Project #3	Let R1 = 20
		R2 = 25
		NPV 1 = 801.31
		NPV 2 = 662.18
		IRR =	20+	801.31X(25-20)
				801-662
				48.81%	Approx
	Project #4	Let R1 = 20
		R2 = 25
		NPV 1 = 878.04
		NPV 2 = 708.18
		IRR =	20+	878.04X(25-20)
				878.04-708.18
				45.84%	Approx
4	Based on NPV, project 4 is best as it gives highest NPV