Question

Project A requires an original investment of $62,000. The project will yield cash flows of $18,600 per year for 4 years. Project B has a computed net present value of $3,690 over a 4-year life. Project A could be sold at the end of 4 years for a price of $14,900.

Following is a table for the present value of $1 at compound interest:

Year		6%		10%		12%
1		0.943		0.909		0.893
2		0.890		0.826		0.797
3		0.840		0.751		0.712
4		0.792		0.683		0.636
5		0.747		0.621		0.567

Following is a table for the present value of an annuity of $1 at compound interest:

Year		6%		10%		12%
1		0.943		0.909		0.893
2		1.833		1.736		1.690
3		2.673		2.487		2.402
4		3.465		3.170		3.037
5		4.212		3.791		3.605

Use the tables above.

a. Determine the net present value of Project A over a 4-year life with salvage value assuming a minimum rate of return of 12%. Round your answer to two decimal places.
$

b. Which project provides the greatest net present value?

Answer 1

Net present value = Present value of future cash inflows - Original investment.

To find the present value of project A, we need to find the present value of cash flows. Since the cash flows are uniform over the years, we can use the present value of an annuity of $1 at compound interest of 12% for 4 years. i.e PV factor = 3.037. (from the 2nd table). And for cash flow from the sale of the project, we can use the present value of $1 at a compound interest of 12% for 4 years i.e PV factor = 0.636 (from 1st table).

The present value of cash inflows = $18,600 * 3.037 =  $56,488.20

The present value of cash flows from the sale of asset =  $14,900 * 0.636 =  $9,476.40

Therefore, sum total of present value of cash inflows =  $56,488.20 + $9,476.40 = $65,964.60

Therefore,

a) Net Present Value = $65,964.60 - $62,000.00 = $3,964.60

Conclusion:

NPV of Project A = $3,964.60

NPV of Project B = $3,690.00 ..............(given)

b) When you compare NPVs of both the projects, we can see that Project A has the greatest Net Present Value.