Challenge 4 30 Points Use the conceptsmethods related to the

Challenge 4. (30 Points) Use the concepts/methods related to the lectures on Financial Assessment to address the following challenge A manager of an engineering firm has to evaluate 4 projects. The NPV of the investment and the equivalent uniform annual net benefits (not including the investment) are given. The manager is trying to decide if the annual net benefits are large enough to justify any of the investments. The minimum acceptable rate of return for the engineering firm is 10% Problem 7 Investment and Benefit Data for Four Projects Investment (NPV as of time zero) $1 million $2 million $2.6 million $4 million NPV (Using capital worth method) Equivalent Annual Net Benefits $130,000 $190,000 $286,000 $480,000 Project IRR Question 4.a. (10 Points) Calculate the NPV and the IRR for each project and fill in Table 1.1. In calculating the NPV, assume the annual net benefits continue forever, so that you can use the capital worth method Assume that these projects are independent, so that the firm could carry out any or all of them. Which projects are justified using the NPV method? Question 4.b. (10 Points) Which are justified using the IRR method? Question 4.c. (10 Points) Assume that these projects are mutually exclusive alternatives for developing c site. Which proiect is best? Wh

Solution

(i) Project Investment Eq. Annual Benefits NPV using capital worth menthod IRR A 1000000 130000 300000 13.00% B 2000000 190000 -100000 9.50% C 2600000 286000 260000 11.00% D 4000000 480000 800000 12.00% Project A - NPV - PV of Net Annual Benefits (as the benefits are for indefinate time, we will consider it as annuity) For an annuity A = P/i PV of Net Annual Benefits 130000/0.10 = 1300000 Less: Investment 1000000 NPV - 300000 IRR - It is the rate at which NPV becomes zero - Let the rate be r - 130000/r - 1000000 = 0 130000/r = 1000000 r= 130000/1000000 Rate = 0.13 Use the same calculation for other 4 projects. (ii) All those projects which have a positive NPV are acceptable. If the project has a IRR of 10% or more then it is acceptable. Therefore as per NPV & IRR analysis folowing projects are acceptable - Project A C D (iii) NPV - Project D is the best as it has the highest NPV. IRR - Project A is the best as its IRR is the highest.