Question 1

Two new software projects are proposed to a young, start-up company. The Alpha project
will cost $150,000 to develop and is expected to have annual net cash flow of $40,000. The
Beta project will cost $200,000 to develop and is expected to have annual net cash flow of
$50,000. The company is very concerned about their cash flow. Using the payback period,
which project is better from a cash flow standpoint? Why?

Solution 1

Payback =

Alpha Project:

$ ,
Payback = 3.75 𝑦𝑒𝑎𝑟𝑠
$

Beta Project:

$ ,
Payback = 4.00 𝑦𝑒𝑎𝑟𝑠
$

Conclusion: Project Alpha is the better project due to its shorter payback period
Question 2

A five-year project has a projected net cash flow of $15,000, $25,000, $30,000, $20,000, and
$15,000 in the next five years. It will cost $50,000 to implement the project. If the required
rate of return is 20 percent, conduct a discounted cash flow calculation to determine the
NPV.

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Solution 2

Given:
Initial Investment (C0) = $ 50,000
Net cash inflow for period t (Ft) = $15,000. ,$25,000. , $30,000. , $20,000. & $15000.
Required rate of return (r) = 20 %

Formula used:

Project NPV = - C0 +
^

, , , , ,
Project NPV= -$50,000+ ( . ^
)+ ( . ^
)+ ( . ^
)+ ( . ^
)+ ( . ^
)
= - $ 50,000 + $ 12,500 + $ 17,361.11 + $ 17,361.11 + $9,645.06 + $6,028.16
= $12,895.44

Conclusion: The NPV is positive therefore the project can be accepted

Question 3

You are the head of the project selection team at Broken Arrow records. Your team is
considering three different recording projects. Based on past history, Broken Arrow
expects at least a rate of return of 20 percent. Your financial advisors predict inflation to
remain at 2 percent into the foreseeable future. Given the following information for each
project, which one should be Broken Arrow’s first priority? Should Broken Arrow fund any of
the other projects? If so, what should be the order of priority based on return on
investment?

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Solution 3
Given:
Rate of return = 20% (0.2)
Rate of inflation = 2% (0.02)

Formula used:
Rate for discount = Rate of return + Rate of Inflation = 20 + 2 = 22% (0.22)

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Project NPV = - C0 +
^

Time Fades away

Project NPV= -$600,000 +
, , , , ,
( . ^
)+ ( . ^
)+ ( . ^
)+( . ^
)+ ( . ^
)
= - $ 600,000 + $ 491,803.28 + $ 50,389.68 + $ 11,014.14 + $ 6,770.99 +
$ 3,699.99
= - $36,321.92

Time Fades Away

Year Inflows Outflows Net flow DF NPV
0 600,000 -600,000 1.00 -600,000
1 600,000 600,000 0.82 491,803
2 75,000 75,000 0.67 50,390
3 20,000 20,000 0.55 11,014
4 15,000 15,000 0.45 6,771
5 10,000 10,000 0.37 3,700
TOTAL - 36,322

On the Beach
Project NPV= -$400,000 +
, , , , ,
( . ^
)+ ( . ^
)+ ( . ^
)+( . ^
)+ ( . ^
)
= - $ 600,000 + $ 327,868.85 + $ 67,186.24 + $ 13,767.67 + $ 9,027.98 +
$ 3,699.99
= $ 21,550.73

On the Beach
Year Inflows Outflows Net flow DF NPV
0 400,000 - 400,000 1.00 - 400,000
1 400,000 400,000 0.82 327,869
2 100,000 100,000 0.67 67,186

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 3 25,000 25,000 0.55 13,768
4 20,000 20,000 0.45 9,028
5 10,000 10,000 0.37 3,700
TOTAL $21,551

Tonight’s the Night

Project NPV= -$200,000 +
, , , , ,
( . ^
)+ ( . ^
)+ ( . ^
)+( . ^
)+ ( . ^
)
= - $ 200,000 + $ 163,394.43 + $ 83,982.80 + $ 41,303.02 + $ 9,027.98 +
$ 3,699.99
= $ 101,408.22

Tonight’s the Night

Year Inflows Outflows Net flow DF NPV
0 200,000 - 200,000 1.00 - 200,000
1 200,000 200,000 0.82 163,394
2 125,000 125,000 0.67 83,983
3 75,000 75,000 0.55 41,303
4 20,000 20,000 0.45 9,028
5 10,000 10,000 0.37 3,700
TOTAL $101,408

Conclusion: Broken Arrow should choose to firstly invest in the Tonight’s the Night
project, then they can follow up with the On the Beach project. The Time Fades Away
project proves no feasible based on the company’s expectations.

Question 4

There two projects, A and B, with the following cash flows. The discount rate is at 10
percent. Which project should be selected? Use the IRR method.

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Solution 4

Given:
Discount rate (r) = 10% (0.1)

Project A:

NPV = 𝐶𝑜
^

,
= -1,000 + = $ 909.09
. ^

IRR => 𝐶𝑜 =0
^
,
=> 1,000 =0
^
2100
=> = 1,000
1 𝐼𝑅𝑅 ^1

=> = 1,000

=> 2,100 = 1,000 + 1,000 IRR

=> 1,100 = 1,000 IRR
=> IRR = 1.1 = 110%

Project B:

NPV = 𝐶𝑜
^

,
= -10,000 + = $ 3,636.36
. ^

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IRR => 𝐶𝑜 =0
^
,
=> 10,000 =0
^
15,000
=> = 10,000
1 𝐼𝑅𝑅 ^1
,
=> = 10,000

=> 15,000 = 10,000 + 10,000 IRR

=> 5,000 = 10,000 IRR
=> IRR = 0.5 = 50%

Conclusion: Project A has a higher IRR but a lower NPV while project B has a lower IRR but
a higher NPV. Project B should be selected because this presents the maximum value to the
investors.

Question 5
Suppose that you were offered the investment shown below at a cost of $800. What is the
NPV and IRR? Do the calculations manually (show the working out) and also with Excel.
Attach the Excel spreadsheet to your work. Submit the completed sheet.

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Solution 5
Given:
Rate of return (r) = 12% (0.12)
Initial Investment (C0) = $ 800
Net cash inflow for period t (Ft) = $100. ,$200. , $300. , $400. & $500.

Formula used:

Project NPV = - C0 +
^

Project NPV= -$800 +

( . ^
)+ ( . ^
)+ ( . ^
)+( . ^
)+ ( . ^
)
= - $ 800 + $89.29 + $159.44 + $ 213.53 + $ 254.21+ $ 283.71

= $200.18
IRR
The IRR is the rate of return where the NPV is equal to zero (0). Since the NPV for a 12%
rate of return is positive then we’ll start guessing higher than 12%.

Guess #1: 20%

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Project NPV= - $ 800 + ( . ^
)+ ( . ^
)+ ( . ^
)+ ( . ^
)+ ( . ^
)
= - $ 800 + $83.33 + $138.89 + $ 173.61 + $ 192.90+ $ 200.94

= - $10.33

The NPV for a 20% rate of return is slightly negative so we’ll start guess a little lower than
20%.

Guess #2: 18%

Project NPV= - $ 800 +

( . ^
)+ ( . ^
)+ ( . ^
)+( . ^
)+ ( . ^
)
= - $ 800 + $84.74 + $143.64 + $ 182.59 + $ 206.32 + $ 218.55

= $35.84

The NPV for a 18% rate of return is positive so we’ll start guess a little higher than 18%.

Guess #3: 19.5%

Project NPV= - $ 800 +

( . ^
)+ ( . ^
)+ ( . ^
)+( . ^
)+ ( . ^
)
= - $ 800 + $83.68 + $140.05 + $ 175.80 + $ 196.15 + $ 205.18

= $0.86

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The NPV for a 19.5% rate of return is slightly positive so we’ll start guess a little higher than
19.5%.

Guess #4: 19.6%

Project NPV= - $ 800 +

( . ^
)+ ( . ^
)+ ( . ^
)+( . ^
)+ ( . ^
)
= - $ 800 + $83.61 + $139.82 + $ 175.36 + $ 195.49 + $ 204.32

= - $1.40

At this point it seems that a 19.5% rate of return is the most suitable value.

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