Answer to Question #264187 in Financial Math for Kwabenya

Question

A company wants to undertake an investment and has two projects under consideration. Project 1 will have a useful life of 7 years whereas project 2 would have a useful life of 6 years. Project 1 would also require an initial investment of GHc300,000 plus an additional repair cost of GHc20,000 on year 6. Project 2 would also require an initial investment of GHc240,000 plus an additional repair cost of GHc25,000 in years 4 and 5. Project 1 and 2 have an estimated salvage value of GHc5000 and GHC3000 respectively. Due to different project risk, project 1 and project 2 would be evaluated at an interest rate of 10% and 12% per year respectively. Project profits are estimated to be GHc100,000 and GHc100,000 per year respectively for both projects starting at the end of year 1 till the end of their respective project lifespans.

Using the NPV approach, determine which project the company must invest in.

Answer 1

Calculation of NPV of Project 1 and Project 2 is as follows:

Workings:

Calculations:

Answer: NPV of Project 1 is GHC 178,118.19 and NPV of Project 2 is GHC 142,587.00. As NPV of Project 1 is greater than Project 2. Hence Project 1 should be selected.