In the following problems, you will calculate the “simple metrics” for project selection. For these problems, please use the following data and assume discount rate (interest rate) of 0.06.
Project A
The upfront cost of the project is $500,000. This cost is incurred in year 1. The profits from product sales will come in years 2 through 5. After year 5, the product will be obsolete, so no profits will come in after year 5.
Profits in year 2: $100,000; Profits in year 3: $200,000; Profits in year 4: $250,000; Profits in year 5: $200,000
Project B
The up front cost of the project is $800,000. This cost is incurred in year 1. The profits from product sales will come in years 2 through 5. After year 5, the product will be obsolete, so no profits will come in after year 5.
Profits at end of year 2: $0; Profits at end of year 3: $200,000; Profits at end of year 4: $400,000; Profits at end of year 5: $600,000
1. Calculate ROI for both projects.
2. Calculate NPV for both projects.
3. Calculate IRR for both projects.
4. For E(NPV), we need to change the scenario. Let’s now pretend that Projects A and B are not two different projects but rather are two different estimates of cash flows for the same project. Assuming the probability of each to be 0.5, calculate E(NPV).
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