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Postby Sud Wed Aug 13, 2014 2:07 pm

A company has to make a choice between two projects, because the available resources in money and kind are not sufficient to run both at the same time. Each project would take 9 months and would cost $250,000.
The first project is a process optimization which would result in a cost reduction of $120,000 per year. This benefit would be achieved immediately after the end of the project.

The second project would be the development of a new product which could produce the following net profits after the end of the project:
1. year: $ 15,000
2. year: $ 125,000
3. year: $ 220,000

Assumed is a discount rate of 5% per year. Looking at the present values of the benefits of these projects in the first 3 years, what is true?

A Both projects are equally attractive.
B The first project is more attractive by app. 7%.
C The second project is more attractive by app. 5%.
D The first project is more attractive by app. 3%.


Is the right answer A. For first project (120000+120000+120000 = 360000) and for second project (15000+125000+220000 = 360000). So the future values after 3 years are same for both. Since the discount rate is given as same for both i.e. 5% per year, should not be the Present values of both also same???

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Postby sunku65 Wed Aug 13, 2014 3:34 pm

First project:
NPV = 120K/1.05 + 120K/(1.05*1.05) + 120K/(1.05*1.05*1.05) = 327K

Second Project
NPV = 15K/1.05 + 125K/(1.05*1.05) + 220K/(1.05*1.05*1.05) = 317K

FIRST PROJECT NPV = 327/317 = 1.03 -1 = 0.03% approx IS MORETHAN SECOND.

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