Your manager has tasked you with evaluating two alternative projects for the companys expansion:

The first option costs $200,000 with the expected cash inflow to the firm estimated at $60,000 per year after depreciation and tax. The life of this project is 7 years.

The second option costs $350,000 and has a life span of 10 years. The cash inflow to the firm from this option is estimated to be $80,000 per annum, again after depreciation and tax.

This company has a cost of capital of 15%. Assume other similar projects will be implemented at the end of these two projects, whichever is chosen.

1. Calculate, for both projects, the:
   1. Internal Rate of Return (IRR)
   2. Net Present Value
   3. Profitability Index (PI) and;
   4. Payback period for project 1 and 2. (8 marks)
2. Can NPV be used to rank the projects? If not, what should you do? Explain fully which project should be chosen. (3 marks)
3. Identify, describe and discuss some of the limitations associated with the use of the NPV in analysing projects? (2 marks)

Insert your answer for Question 3 below.

QUESTION B-4 [18 marks]

Again, your manager has tasked you with providing a recommendation regarding two alternative projects. You have identified the following two projects with the following characteristics:

Project A Project B

CAPEX / Initial Outlay $500,000 $300,000

Project life 5 years 6 years

Revenue (per year) $350,000 $250,000

Variable costs $90,000 $80,000

Operating expense $60,000 $40,000

Investment in Net Working Capital (Year 0) $50,000 $30,000

The companys tax rate is 30% and uses a straight-line depreciation method. There will be no salvage value associated with these projects at the end of their project life. The company also anticipates it will recover all of the NWC at the end of the project. The company has a required rate of return of 13% per annum.

1. Determine the Free Cash Flows, for each year, to the firm for both projects. (7 marks)

2. Identify which project you recommend the company invest. (3 marks)

3. Using your own words, briefly describe how to use the techniques of sensitivity, scenario and simulation analyses to estimate project risk? (8 marks)