Explain why profitable firms might face liquidity problems, and what controls and measures should be used to manage the factors that influence liquidity.

A firm which finds its good management of working capital has left itwith surplus cash of 100,000 and is considering 2 investment projectopportunities, only one of which can be financed. The details are as follows:

InvestmentTerm Inv A 100,000 Inv B 100,000

4 years 5 years

Expected cash flows:

Year 1 50,000 40,000

Year 2 50,000 42,500

Year 3 50,000 45,000

Year 4 50,000 47,500

Year 5 - 50,000

Residual value Nil Nil

The firm currently enjoys a 20% return on its capital employed, and is not interested in investing in any project yielding a lower return. Using the'Simple Payback' andNPV method of investment appraisal, analyse the foregoing and recommend which investment project the firm should choose, and why.

20% Discount factors

Year 1 Year 2 Year 3 Year 4 Year 5

0.833 0.694 0.579 0.482 0.402