MGT201 GDB

MGT201 - Financial Management
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:

Year
Cash inflows (Rs.)
2009
2000
2010
3000
2011
4000
2012
3000
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.

ANSWER:
Proposal 1:
NPV = -IO + SummationCFt/(1+i)^t
Now,
-IO = -5,000CFt = cash inflows for 1st, 2nd,3rd and 4th years are 2000, 3000, 4000 and 3000 respectively.i = 10%t = 4
Putting the values in the above formula:
NPV = -5000 + [2000/(1+0.1) + 3000/(1+0.1)^2 + 4000/(1+0.1)^3 + 3000/(1+0.1)^4]
NPV = +4351 Rs.
Proposal 2:
(i) XYZ Corporation:
-IO = -3000CFt = 1000 for 4 yearsi = 10%t = 4
Putting the values in NPV formula:
NPV1 = -3000 + [1000/(1+0.1) + 1000/(1+0.1)^2 + 1000/(1+0.1)^3 + 1000/(1+0.1)^4]
NPV1 = 169 Rs.
(ii) ABC Corporation:
-IO = -2000CFt = 2000 for 4 yearsi = 10%t = 4
NPV2 = -2000 + [2000/(1+0.1) + 2000/(1+0.1)^2 + 2000/(1+0.1)^3 + 2000/(1+0.1)^4]
NPV2 = 4340 Rs.
By adding NPV1 and NPV2, we'll get
NPV = NPV1 + NPV2NPV = +4509 Rs.
Since, NPV of proposal 2 is higher than proposal 1, so proposal 2 should be preferred.