Answer to Question #199745 in Finance for Mohamed Shehroz as

Question

1. Mrs Alis is an intelligent business woman. She makes her investments after a very thoughtful process. In January 2018 , her manager has shown her some projects with the following details 

Option A

Investment into a towel business that initially cost $200,000 and then will generate cash inflow of $24000 per year for the next 10 years

Option B

Investment into a detergent business that initially cost $190,000 and then will generate cash inflow of $20,000 for each of next 12 years. 

The rate of return associated with both the investments is 12%. 

a. Calculate net present value (NPV) and internal rate of return (IRR) of both the investments. 

b. Comment on which investment Mrs Alis should pick on the basis NPV and IRR.

Answer 1

Initial investment of A is $200,000

Cash inflow is $24,000 for next 10 years

Initial investment of B is $190,000

Cash inflow is $20,000 for next 12 years

Rate of return is 12%

Calculation of Net present value (NPV) and Internal rate of return (IRR):

Excel workings:

Since, both the projects are having negative NPVs, both the projects should be rejected, if he wants to make investment in any of the project he should advised to select the project having lowest NPV (Option A). Based on the IRR criteria, highest IRR should be selected. So, select option B.