Question

The following information relates to Tinaye company which is intending on investing in a new project to maximize its value and requires an assistance of an analyst in determining which project is more worthwhile.

PERIOD PROJECT A PROJECT B PROJECT C
0 (R 50 000) (R30 000) (R40 000)
1 R14 000 R8 000 R20 000
2 R20 000 R4 000 R20 000
3 R26 000 R12 000 R5 000
4 R5 000 R10 000
5 R9 000

Assume WACC of 8%

Required:

Determine which of the three projects is more worthwhile by using Net Present Value method. (20 Marks)

Answer 1

[AI-generated answer — Bot GPT 3.5]

To calculate the Net Present Value (NPV) for each project, we need to discount the cash flows at the given WACC of 8%. The formula for calculating NPV is:

\[ NPV = \sum_{t=0}^{T} \frac{Cash Flow_t}{(1 + WACC)^t} - Initial Investment \]

Where:
- \( Cash Flow_t \) = cash flow at time t
- \( WACC \) = Weighted Average Cost of Capital (8% in this case)
- \( Initial Investment \) = initial investment at time 0
- \( T \) = number of periods

Project A:
- NPV = (-50,000)/(1+0.08)^0 + 14,000/(1+0.08)^1 + 20,000/(1+0.08)^2 + 26,000/(1+0.08)^3 + 5,000/(1+0.08)^4 + 0/(1+0.08)^5
- NPV = -50,000 + 12,963.00 + 18,518.52 + 20,444.50 + 3,596.30 + 0
- NPV = $5,522.32

Project B:
- NPV = (-30,000)/(1+0.08)^0 + 8,000/(1+0.08)^1 + 4,000/(1+0.08)^2 + 12,000/(1+0.08)^3 + 10,000/(1+0.08)^4 + 0/(1+0.08)^5
- NPV = -30,000 + 7,407.41 + 3,348.21 + 11,002.69 + 7,453.06 + 0
- NPV = $66,11.38

Project C:
- NPV = (-40,000)/(1+0.08)^0 + 20,000/(1+0.08)^1 + 20,000/(1+0.08)^2 + 5,000/(1+0.08)^3 + 0/(1+0.08)^4 + 9,000/(1+0.08)^5
- NPV = -40,000 + 18,518.52 + 16,460.91 + 4,989.34 + 0 + 6,912.90
- NPV = $6,881.67

Based on the NPV calculations, Project B has the highest NPV of $6,112.38, making it the most worthwhile project to invest in.