Worked Example — Comparing Two Projects
Fenton Packaging Ltd
Fenton Packaging must choose between Project P and Project Q. Only one can be undertaken. The required rate of return is 10%.
| Project P | Project Q |
|---|
| Initial cost (Year 0) | (£40 000) | (£50 000) |
| Year 1 | £12 000 | £16 000 |
| Year 2 | £18 000 | £17 000 |
| Year 3 | £10 000 | £9 000 |
| Year 4 | £9 000 | £8 000 |
| Year 5 | £5 000 | £6 000 |
Scrap value of £3 000 is already included in Year 5 figures for both projects.
Step 1 — Payback Period
| Year | Project P cumulative (£) | Project Q cumulative (£) |
|---|
| 0 | (40 000) | (50 000) |
| 1 | (28 000) | (34 000) |
| 2 | (10 000) | (17 000) |
| 3 | 0 | (8 000) |
| 4 | 9 000 | 0 |
| 5 | 14 000 | 6 000 |
- Project P payback = 3 years
- Project Q payback = 4 years
- On payback alone: Project P preferred (shorter payback)
Step 2 — NPV at 10%
| Year | Factor | Project P PV (£) | Project Q PV (£) |
|---|
| 0 | 1.000 | (40 000) | (50 000) |
| 1 | 0.909 | 10 908 | 14 544 |
| 2 | 0.826 | 14 868 | 14 042 |
| 3 | 0.751 | 7 510 | 6 759 |
| 4 | 0.683 | 6 147 | 5 464 |
|
- Project P NPV = +£2 538 (positive — meets the 10% requirement)
- Project Q NPV = −£5 465 (negative — does NOT meet the 10% requirement)
Conclusion
Both projects have a payback period within 4 years. However, only Project P has a positive NPV. Project P is recommended — subject to non-financial considerations.