Question

Assuming a 10% discount rate, calculate the NPV of the four projects and rank the projects in order of preference. Show steps.

1. Growth Enterprise, Inc. (GEI) has $40 million that it can invest in any or all of the four capital investment projects (A, B, C, D), which have cash flows as shown in the following table. Table 1. Comparison of Project Cash Flows ($ thousand dollars) Project Type of Year 0 Year 1 Year 2 Year 3 cash flow A. Investment -$10,000 Revenue $21,000 Operating $11,000 expense 0 olo B. -$10,000 | Investment Revenue Operating expense $15,000 $5,833 $17,000 $7,833 -$10,000 0 0 Investment Revenue Operating expense $10,000 $5,555 $11,000 $4,889 $30,000 $15,555 0 Investment -$10,000 0 Revenue $30,000 $10,000 Operating $15,555 $5,555 expense • All revenues and operating expenses can be considered cash items. 0 $5,000 $2,222 Each of these projects is considered to be of equivalent risk. The investment will be depreciated to zero on a straight-line basis for tax purpose. For simplicity, the depreciation per year for a project is equal to the project investment value divided by the life of the project. Project A has 1-year life, Project B has two-year life, and both Project C and D have 3-yar life. GEI's marginal corporate tax rate on taxable income is 40%. None of the projects will have any salvage value at the end of their respective lives.

Answer 1

A:	Year 0	Year 1
Revenue		21,000.00
less: operating expense		-11,000.00
less: depreciation		-10,000.00
EBIT		0.00
Tax @ 40%		0.00
Net income		0.00
EBIT		0.00
Add: Depreciation		10,000.00
less: tax		0.00
Operating cash flow		10,000.00
Capital spending	-10,000.00
Total cash flow	-10,000.00	10,000.00
1+r	1.10
PVIF	1.00000	0.90909
PV = Total cash flow*PVIF	-10,000.00	9,090.91
NPV = sum of all PVs	-909.09
B:	Year 0	Year 1	Year 2
Revenue		15,000	17,000
less: operating expense		-5,833	-7,833
less: depreciation		-5,000	-5,000
EBIT		4,167.00	4,167.00
Tax @ 40%		1,666.80	1,666.80
Net income		2,500.20	2,500.20
EBIT		4,167.00	4,167.00
Add: Depreciation		5,000.00	5,000.00
less: tax		-1,666.80	-1,666.80
Operating cash flow		7,500.20	7,500.20
Capital spending	-10,000.00
Total cash flow	-10,000.00	7,500.20	7,500.20
1+r	1.10
PVIF	1.00000	0.90909	0.82645
PV = Total cash flow*PVIF	-10,000.00	6,818.36	6,198.51
NPV = sum of all PVs	3,016.88
C:	Year 0	Year 1	Year 2	Year 3
Revenue		10,000.00	11,000.00	30,000.00
less: operating expense		-5,555.00	-4,889.00	-15,555.00
less: depreciation		-3,333.33	-3,333.33	-3,333.33
EBIT		1,111.67	2,777.67	11,111.67
Tax @ 40%		444.67	1,111.07	4,444.67
Net income		667.00	1,666.60	6,667.00
EBIT		1,111.67	2,777.67	11,111.67
Add: Depreciation		3,333.33	3,333.33	3,333.33
less: tax		-444.67	-1,111.07	-4,444.67
Operating cash flow		4,000.33	4,999.93	10,000.33
Capital spending	-10,000.00
Total cash flow	-10,000.00	4,000.33	4,999.93	10,000.33
1+r	1.10
PVIF	1.00000	0.90909	0.82645	0.75131
PV = Total cash flow*PVIF	-10,000.00	3,636.67	4,132.18	7,513.40
NPV = sum of all PVs	5,282.24
D:	Year 0	Year 1	Year 2	Year 3
Revenue		30,000.00	10,000.00	5,000.00
less: operating expense		-15,555.00	-5,555.00	-2,222.00
less: depreciation		-3,333.33	-3,333.33	-3,333.33
EBIT		11,111.67	1,111.67	-555.33
Tax @ 40%		4,444.67	444.67	-222.13
Net income		6,667.00	667.00	-333.20
EBIT		11,111.67	1,111.67	-555.33
Add: Depreciation		3,333.33	3,333.33	3,333.33
less: tax		-4,444.67	-444.67	222.13
Operating cash flow		10,000.33	4,000.33	3,000.13
Capital spending	-10,000.00
Total cash flow	-10,000.00	10,000.33	4,000.33	3,000.13
1+r	1.10
PVIF	1.0000	0.9091	0.8264	0.7513
PV = Total cash flow*PVIF	-10,000.00	9,091.21	3,306.06	2,254.04
NPV = sum of all PVs	4,651.32

NPV of project C is the highest, followed by D and then B. A has a negative NPV.