Question

QUESTION - smith and jones has $500,000 to invest. the company is trying to decide between two alternatives uses of the funds. the alternative follow. Any working capital for projects will be released at the end of the life of the project. The company's discount rate is 12%
			A	B
		Cost of equipment required	400,000	250000
Required-		working capital required	100,000	250000
		annual cash inflows	150,000	120000
Which alternative would you recommend the company accept?		repair required in year 2	10,000	15000
		repair required in year 4	12,000	40000
Show all computation using net present value approach.		salvage value of equipment	70,000	25000
		life of the project	6	6
Prepare separate computation for each project.

Answer 1

Solution :

Computation of NPV - Alternative A
Particulars	Period	PV Factor	Amount	Present Value
Cash outflows:
Cost of Equipment	0	1	$400,000.00	$400,000
Working capital	0	1	$100,000.00	$100,000
Repair required in year 2	2	0.79719	$10,000.00	$7,972
Repair required in year 4	4	0.63552	$12,000.00	$7,626
Present Value of Cash outflows (A)				$515,598
Cash Inflows
Annual cash inflows	1-6	4.11141	$150,000.00	$616,711
Salvage Value	6	0.50663	$70,000.00	$35,464
Recovery of Working capital	6	0.50663	$100,000.00	$50,663
Present Value of Cash Inflows (B)				$702,838
Net Present Value (NPV) (B-A)				$187,240

As NPV for alternative A is highest, therefore company should accept alternative A.

Computation of NPV - Alternative B
Particulars	Period	PV Factor	Amount	Present Value
Cash outflows:
Cost of Equipment	0	1	$250,000.00	$250,000
Working capital	0	1	$250,000.00	$250,000
Repair required in year 2	2	0.79719	$15,000.00	$11,958
Repair required in year 4	4	0.63552	$40,000.00	$25,421
Present Value of Cash outflows (A)				$537,379
Cash Inflows
Annual cash inflows	1-6	4.11141	$120,000.00	$493,369
Salvage Value	6	0.50663	$25,000.00	$12,666
Recovery of Working capital	6	0.50663	$250,000.00	$126,658
Present Value of Cash Inflows (B)				$632,692
Net Present Value (NPV) (B-A)				$95,314