Is there an error in the question/answer/approach for this? There are NPV premiums of 351.59 @ 8% discount for product A and 285.62 for product B, with the same cashflows and survival factors. The risk discount rate isn't mentioned for product B. Given that the NPVs are different but with the same cashflows and survival factors is it correct to infer that either the risk discount rates or the methodologies are different, and if that's the case is it at all reasonable to compare the ratio of NPV profit / NPV premiums as the examiners have done in the next part of the question?
If I understand your question correctly you are asking if you can compare the ratio of NPV/PVP for project A to project B. In addition, you think this comparison is not reasonable because either the methodologies or the risk discount rates (RDRs) are different. Is this correct? I think that it is highly unlikely that the methodology of calculating a present value can change much (unless you mean in advance vs. in arrears), so then it must be the RDR that is different. Remember that the RDR takes into account the riskiness associated with the project, and projects should be compared on a risk adjusted basis. Thus it is quite reasonable to use different discount rates to value the NPV for different projects. So I think that the projects can be compared to one another with the ratio methodology. In any case you should probably choose project A because its NPV is higher. I hope this helps
As Alastair says, different discount rates have been used, suggesting that Product B is riskier than A given the higher discount rate used. You might find using the ASET useful for this type of question as it explains what to do and why in more detail than the Examiners' Report. Sarah
