Project R delegates all the development work to outside companies. The estimated cashflows for Project R are (where brackets indicate expenditure):
Beginning of Year 1 (£150,000) (contractors’ fees)
Beginning of Year 2 (£250,000) (contractors’ fees)
Beginning of Year 3 (£250,000) (contractors’ fees)
End of Year 3 £1,000,000 (sales)
Project S carries out all the development work in-house by purchasing the necessary equipment and using the company’s own staff. The estimated cashflows for Project S are:
Beginning of Year 1 (£150,000) (New equipment)
Continuous payments Through Year 1 (£75,000) (Staff Cost)
Continuous payments Through Year 2 (£250,000) (Staff Cost)
Continuous payments Through Year 3 (£250,000) (Staff Cost)
End of Year 3 £1,000,000 (sales)
a) Calculate the net present value for Project R and Project S using a risk discount rate of 20% per annum. Using net present values as a criterion, which project is preferable?
b) Find the internal rate of return for Project R and Project S and hence determine which project is more favourable using this criterion.