Question 1

The financial management team of a large business is considering undertaking one of three mutually exclusive investment projects. Details on each project are provided below:

Project 1:

The project will require an initial investment of $400,000 today and is expected to result in cash inflows of $90,000 per year for 9 years. The first cash inflow will occur in 3 years time.

Project 2:

The project will require and initial investment of $300,000 today and is expected to result in cash inflows of $30,000 per year for the foreseeable future. The first cash inflow will occur immediately.

Project 3:

The project will require two investments, one today and another in one years time. The expected cash flows are detailed below:

T0	T1	T2	T3	T4
($100,000)	($150,000)	$170,000	$150,000	$30,000

The companys cost of capital is 9%.

1. Calculate the net present value (NPV) of each project and recommend which project should be undertaken.

(6 marks)

2. Explain why NPV should be used in preference to internal rate of return (IRR) when choosing between mutually exclusive investment projects.

(4 marks, maximum 200 words)

Total for the question 10 marks