Compute the NPV of Project A and Explain its Meaning. Based Solely on the NPV, would You Fund Project A?

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If you were required to fund one of the projects, which would you choose and why?

 

1. Consider two projects, known as Project A and Project B.

Project A requires an initial investment of $1M and is expected to last 8 years. It will have operating expenses of $200k in year 1 and gross receipts of $210k (treat all cash flows as if they occur in a lump at the end of the year, so the $200k and $210k cash flows may be assumed to occur one year from today). In each of years 2-5, it will have expenses of $50k with gross receipts of $225k. Year 6 requires a $200k capital improvement along with operating expenses of $75k and gross receipts are expected to be $200k. Years 7-8 show expected expenses of $100k (each year) with gross receipts of $50k and $25k, respectively. Year 8 will have liquidation proceeds (salvage value) of $75k.

Project B requires an initial investment of $500k and is expected to last 6 years. It will have operating expenses of $400k in year 1 and gross receipts of  $405k. In each of years 2-5, it will have expenses of $150k with gross receipts of $450k. Year 3 will require a refurbishment of equipment at an expected cost of $600k. Year 6 offers expected operating expenses of $75k, and gross receipts are expected to be $200k. Because of EPA regulations, year 6 will also show a site clean up and disposal expense of $200k.

Assume a required rate of return of 20% and an inflation rate of 3%. Base your answers to the following strictly on financial considerations.

1.Compute the NPV of Project A and explain its meaning. Based solely on the NPV, would you fund Project A? Why/why not?

2.Compute the NPV of Project B and explain its meaning. Based solely on the NPV, would you fund Project B? Why/why not?

3.If you were required to fund one of the projects, which would you choose and why?
 
 

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