- 15 Marks
Question
Gaskiya Nigeria Limited is considering whether or not to invest in any of the two projects where the initial cash investment would be ₦13,000,000 for A and ₦14,000,000 for B. The projects would have a five-year life and the estimated annual cash flows are as follows:
| Year | Project A (N) | Project A Outflows (N) | Project B (N) | Project B Outflows (N) |
|---|---|---|---|---|
| 1 | 6,000,000 | 3,000,000 | 10,000,000 | 5,000,000 |
| 2 | 8,000,000 | 4,000,000 | 9,000,000 | 4,000,000 |
| 3 | 10,000,000 | 4,000,000 | 8,000,000 | 3,000,000 |
| 4 | 9,000,000 | 3,000,000 | 8,000,000 | 3,000,000 |
| 5 | 6,000,000 | 3,000,000 | 4,000,000 | 2,000,000 |
The company’s cost of capital is 10%. Several factors could impact the inflows:
- Factor 1: 20% probability of government measures reducing inflows by 25%.
- Factor 2: 30% probability of a competitor entering the market, reducing inflows by 10%.
- Factor 3: 40% probability of stronger-than-expected demand, increasing inflows by 5%.
Required:
a. Calculate the expected net present value of the two projects. (13 Marks)
b. Which of the projects will be more profitable? (2 Marks)
Answer
GASKIYA NIG LTD
a. Calculation of the expected net present value of the two Projects
Computation of joint Probability distribution
Impact on inflow
Thus the EV of considering the 3 factors is 0.94. Therefore the NPV of Project
A and B are:
Project A
Project B
b. Project A will be more profitable with a higher NPV of N1,731.30
- Tags: Expected Value, Net Present Value, Project Appraisal, Risk analysis
- Level: Level 2
- Topic: Decision-making techniques
- Series: NOV 2021
- Uploader: Kwame Aikins