Question

Good old XYZ Corp. is considering two mutually exclusive projects, A & B in order to expand their product line. The cost accountants determined the following: A’s initial investment must be $42,400, while project B will cost $60,000.

Project A has projected cash flows of $23,000 a year, and project B of $24,000 a year. The project should last 3 years.  

In addition, the following rates has been given: the prime = 7%; Labor = 6%; the firm’s cost of capital = 12%; and the risk-free rate = 3%

Directions:

Using the NPV analysis method, compute the NPV for project A and B and determine which project would you rather accept. (show all your computation).

Answer 1

PROJECT - A

Annual Cash Flow	$23,000
Present Value annuity Factor at 12% for 3 Years	2.401831
Present Value of Annual Cash Flows	$ 55242.12
Less : Initial Investment or amount to be invested	$(42,400.00)
Net Present Value (NPV)	$ 12,842.12

PROJECT - B

Annual Cash Flow	$24,000
Present Value annuity Factor at 12% for 3 Years	2.401831
Present Value of Annual Cash Flows	$ 57,643.95
Less : Initial Investment or amount to be invested	$(60,000.00)
Net Present Value (NPV)	$(2,356.05)

DECISION

“PROJECT – A” Should be accepted. Under NPV, Project Acceptance criteria is based on whether the NPV of the project is positive or negative. If the NPV is positive, then the project should be accepted else reject. In this case, the Project – A has a positive NPV of  $ 12,842.12, Hence Project – A should be accepted