In a small seaside community called Reform Village, a huge company is proposing to enter one of two projects. Project A is to build a five storey hotel on the pristine beachfront of Reform Village. Project B is to build twenty self- contained log cabins along the beach with an additional two cabins for a restaurant and health spa. Each project requires an initial investment of $2 000 000 and has no salvage value. The investing company estimates the cost of capital to be 10%. The company must choose either project A or Project B. The following cash flows are projected for Project A and Project B over five years Year Project A Project B 2000 $600 000 0 2001 600 000 400 000 2002 600 000 400 000 2003 600 000 1 000 000 2004 600 000 1 800 000 Additional Information The citizens of Reform Village are divided over which project will benefit the villagers most. Some villagers prefer the high rise hotel because of its potential for more jobs for villagers as cleaners, cooks and waiters. In addition, villagers perceive that during the construction the need for ordinary and skilled labour will help the large proportion of unemployed young men in the village. Some villagers on the other hand, believe the high rise hotel will threaten the local ecology by its sheer size and extensive tunnelling necessary to erect such a structure on the beachfront. These villagers will prefer to see smaller less imposing cabins constructed that will maintain the village theme ant that will not significantly affect the natural environment. Labour for these construction of these cabins will be somewhat less than for the hotel but very skilled carpenters will be needed. There will be a high demand for cooks, cleaners and swimming instructors as the cabin project will target families and aim to meet their personal needs for special foods, baby sitters and cleaners. The villagers are a very powerful group and can have an influence on the profitability of either project. Required: a. Compute the payback period on each project. b. Using the payback period criterion, which project is more desirable? c. Compute the net present value of each project. d. Using the NPV criterion, which project is more desirable? e. List three non-financial factors mentioned in the problem which are important for evaluating whether to invest in Project A or Project B. f. Based on your calculations of the payback period, net Present Value and the nonfinancial factors listed in (e) discuss why the investors should choose: (i) Project A (ii) Project B
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
This question is not grared.
In a small seaside community called Reform Village, a huge company is proposing to enter
one of two projects. Project A is to build a five storey hotel on the pristine beachfront of
Reform Village. Project B is to build twenty self- contained log cabins along the beach with
an additional two cabins for a restaurant and health spa.
Each project requires an initial investment of $2 000 000 and has no salvage value. The
investing company estimates the cost of capital to be 10%. The company must choose either
project A or Project B. The following cash flows are projected for Project A and Project B
over five years
Year Project A Project B
2000 $600 000 0
2001 600 000 400 000
2002 600 000 400 000
2003 600 000 1 000 000
2004 600 000 1 800 000
Additional Information
The citizens of Reform Village are divided over which project will benefit the villagers most.
Some villagers prefer the high rise hotel because of its potential for more jobs for villagers as
cleaners, cooks and waiters. In addition, villagers perceive that during the construction the
need for ordinary and skilled labour will help the large proportion of
in the village.
Some villagers on the other hand, believe the high rise hotel will threaten the local ecology
by its sheer size and extensive tunnelling necessary to erect such a structure on the
beachfront. These villagers will prefer to see smaller less imposing cabins constructed that
will maintain the village theme ant that will not significantly affect the natural environment.
Labour for these construction of these cabins will be somewhat less than for the hotel but
very skilled carpenters will be needed. There will be a high demand for cooks, cleaners and
swimming instructors as the cabin project will target families and aim to meet their personal
needs for special foods, baby sitters and cleaners. The villagers are a very powerful group
and can have an influence on the profitability of either project.
Required:
a. Compute the payback period on each project.
b. Using the payback period criterion, which project is more desirable?
c. Compute the
d. Using the NPV criterion, which project is more desirable?
e. List three non-financial factors mentioned in the problem which are important for
evaluating whether to invest in Project A or Project B.
f. Based on your calculations of the payback period, net Present Value and the nonfinancial factors listed in (e) discuss why the investors should choose:
(i) Project A
(ii) Project B
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