Capital Financing

Question 1

a) What is the Net Present Value (NPV) of each investment? Which investment (if either) should the company undertake?

 [pic 1]

Or, reflecting the outlay as CF0,

         [pic 2]

Where,

CFt        = After-tax cash flow at time t

r        = Discount rate

Outlay        = Investment cash flow at time zero

1) NPV of LED project

= -RM4,200,000 +  +  +  +  +  +  +  +  +  + [pic 3][pic 4][pic 5][pic 6][pic 7][pic 8][pic 9][pic 10][pic 11][pic 12]

= -RM4,200,000 + RM 636,363.64 + RM 574,512.40 + RM 525,920.36 + RM 478,109.42 + RM 620,921.32 + RM 395,131.75 + RM 359,210.68 + RM 326,555.17 + RM 296,868.33 + RM 269,880.30

=RM 283,473.37

2) NPV of Solar project

= (RM 60,000 x 6.1446) – RM 500,000

= RM 368,676 – RM 500,000

=-RM 131,324

*If NPV > 0: Invest the project because capital project adds value

If NPV < 0: Do not invest the project because capital project destroys value

Thus, company should invest the LED project.

b) David approaches Diana for a favor. David says that the solar lighting project is a ‘pet’ project of his boss, and David really wants to get the project approved to curry favor with his boss. He suggests to Diana that they roll their two projects into single proposal. The cash flows for this combined project would simply equal the sum of the two individual projects. Calculate the NPV of the combined projects. Does it appear to be worth doing? Would you recommend investing in the combined project?