INVESTMENT APPRAISAL HANDOUT
Example
The capital investment committee of a state owned corporation is currently considering two projects. The estimated income from operations and net cash flows expected from each operation are as follows: | PROJECT A | PROJECT B | Year | Income from operations$ | Net Cash Flow$ | Income fromOperations$ | Net Cash Flow$ | 1 | 12,000 | 44,000 | 26,000 | 58,000 | 2 | 18,000 | 50,000 | 20,000 | 52,000 | 3 | 20,000 | 52,000 | 16,000 | 48,000 | 4 | 16,000 | 48,000 | 16,000 | 48,000 | 5 | 22,000 | 54,000 | 6,000 | 38,000 | | 88,000 | 248,000 | 84,000 | 244,000 |

Each project requires an investment of $160,000. Straight line depreciation will be used, and no residual value is expected. The committee has selected a rate of 15% for purposes of the net present value analysis
Required
1. Calculate the following:
a) The average rate of return for each project
b) The net present value for each project. Use the present value of $1 table available on the internet http://highered.mcgraw-hill.com/sites/0072994029/student_view0/present_and_future_value_tables.html 2. Why is the present value of Project B greater than Project A even though its average rate of return is less?
3. Prepare a summary for the capita; investment committee, advising it on the relative merits of the two projects

SOLUTION
1. a ) Average rate of return for Project A
$88,000 /5 = 22%
($160,000 +$0) /2
b) ) Average rate of return for Project B
$84,000 /5 = 21%
($160,000 +$0) /2
b. Net present value analysis: Year | Present ValueOf $1 at 15% | Net Cash Flow ($) | Present Value ofNet Cash Flow ($) | | | Project A | Project B | Project A | Project B | 1 | 0.870 | 44,000 | 58,000 | 38,280 | 50,460 | 2 | 0.756 | 50,000 | 52,000 | 37,800 | 39,312 |