One of your friends, Ali has Rs. 5000 of which he can make either of the two investments offered by XYZ Corporation. On the basis of following information, you are requested to advise him which proposal he should prefer keeping in mind the NPV analysis. Support your decision with necessary calculation.
Proposal 1:
This proposal is for the period of 4 years i.e. 2009 to 2012 and the initial investment is Rs. 5000. Cash inflows are given below:
YearCash inflows (Rs.)
20092000
20103000
20114000
20123000
Proposal 2:
Other option is to invest Rs. 3000 in XYZ Corporation in the year 2009 which will provide him a steady cash inflow of Rs. 1000 for 4 years (year 2009-2012).
And the remaining Rs. 2000 in ABC Corporation in the year 2009 which will provide him a steady cash inflow of Rs. 2000 for 4 years (year 2009-2012).
Whereas, the commercial banks provide 10% return on PLS saving account.
Solution
NPV = − Io +PV (CF1) + PV (CF2) + PV (CF3) + PV (CF4) + ...+ ∞
NPV = -5000 + PV(2000) + PV(3000) + PV( 4000) + PV(3000)
NPV = -5000 + 2000/(1+.10) + 3000/(1+.10)^2 + 4000/(1+.10)^3 + 3000/(1+.10)^4
-5000+ 1818.18 + 2479.33 + 3005.25+ 2049.04 + 9351.82
NPV = 4351.82
Option No.2
NPV = -3000 + 1000/(1+.10) + 3000/(1+.10)^2 + 4000/(1+.10)^3 + 3000/(1+.10)^4
-3000 + 909.09 +826.45+751.31+683.01 = 169.86
NPV = -2000 + 2000/(1+.10) + 2000/(1+.10)^2 + 2000/(1+.10)^3 + 2000/(1+.10)^4
-2000+ 1818.18 +1652.89 +1502.63 + 1366.03 = 4339.73
option 2 = 169+4339.73 = 4509.59
So option 2 is better investment
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