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NPV Examiner’s Report

Forums › FIA Forums › FFM Foundations in Financial Management Forums › NPV Examiner’s Report

  • This topic has 3 replies, 2 voices, and was last updated 8 months ago by mrjonbain.
Viewing 4 posts - 1 through 4 (of 4 total)
  • Author
    Posts
  • November 17, 2021 at 4:21 pm #640917
    april202
    • Topics: 2
    • Replies: 2
    • ☆

    Hi all! can somebody please explain what I am missing here?

    ·A company is considering two mutually exclusive projects. The cash flows for each project are as follows:

    Project X Year0 $ (15,000) Year1 $8,000 Year2 $8,000 Year3 $8,000
    Project Y Year0 $ (15,000) Year 3 $26,000
    The company evaluates projects using the net present value method and uses a cost of capital of 10%.
    Which project(s) should the company undertake?
    A Both projects
    B Project X only
    C Project Y only
    D Neither project

    So, I thought the correct answer was C. But instead of using the NPV factor for 10% in both projects. They use the NPV factor for one and the annuity factor for the other (I think). So this is the answer that they give:

    The candidate therefore needs to
    calculate the net present value of both projects:
    NPV of X = ($15,000) + 2.487 x $8,000 = $4,896
    NPV of Y = ($15,000) + 0.751 x $26,000 = $4,526
    Note that in doing the calculation, I have used annuity factors, which are a valuable tool when
    answering questions under exam time pressure, and yet this is a technique few candidates
    generally use in Section B questions.

    ¿……?

    November 18, 2021 at 7:33 am #640931
    mrjonbain
    Moderator
    • Topics: 1
    • Replies: 1285
    • ☆☆☆☆☆

    Can I confirm answer B is the one given?If they were not mutually exclusive and in the absence of any other constraint, both projects would be chosen as both have positive NPV. The examiner is able to use annuity in this case because equal amount of 8000 is inflow every year of project X. If unequal amounts inflowed each year it would not be possible to use annuity factor. Hope this helps.

    November 21, 2021 at 6:48 pm #641271
    april202
    • Topics: 2
    • Replies: 2
    • ☆

    Hi! Thank you for your response.
    Yes, the correct answer is B (project X only).

    November 22, 2021 at 2:34 am #641274
    mrjonbain
    Moderator
    • Topics: 1
    • Replies: 1285
    • ☆☆☆☆☆

    You are welcome.

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