A company has to make a choice between two projects because the available resources in money and kind are not sufficient to run both at the same time. Each project would take nine months and would cost $250,000.
The first project is a process optimization which would result in a cost reduction of $120,000 per year. This benefit would occur immediately after the end of the project.
The second project would be the development of a new product which could produce the following net profits after the end of the project:
1 year: $15,000
2 year: $125,000
3 year: $220,000
Assumed is a discount rate of 5% per year.
Looking at the present values of the benefits of these projects in the first three years, what is true?
1. Both projects are equally attractive.
2.The first project is more attractive by app. 7%.
3.The second project is more attractive by app. 5%.
4. The first project is more attractive by app. 3%.
Hint: use NPV
I computed NPV in excel for you and showed the approximate difference between the NPV's in percent.