You have a R10 million capital budget and must make the decision about which investments your firm should accept for the coming year. Use the following information on three mutually exclusive projects to determine which investment your firm should accept. The firm's cost of capital is 12 percent.
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Project 1
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Project 2
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Project 3
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Initial cash outflow
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-R 4 000 000
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-R 5 000 000
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-R 10 000 000
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Year 1 cash inflow
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1 000 000
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2 000 000
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4 000 000
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Year 2 cash inflow
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2 000 000
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3 000 000
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6 000 000
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Year 3 cash inflow
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3 000 000
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3 000 000
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5 000 000
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1. Which project do you accept on the basis of NPV?
2. Which project do you accept on the basis of PI?
3. If these are the only investments available, which one do you select?
4. Now assume that another independent project is available to you. This new project has a cost of R5 million, with an NPV of R1.5 million. Given the availability of this new project, which of the mutually exclusive projects do you accept?
5. Is the NPV or PI the better technique in the situation described in part (d)? Why?