Question

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A company has to choose between two different investments. Investment A: This investment requires an immediate...

A company has to choose between two different investments.

Investment A: This investment requires an immediate outlay of $60,000 and another investment of $50,000 in year 3. The investment will return annual profits of $45,000 from year 2 to year 8. At the end of year 8, the investment has a residual value of $20,000.

Investment B: This investment requires an immediate outlay of $25,000 and additional investments of $10,000 per year from year 1 to year 3. The investment will return annual profits of $28,000 from year 4 to year 8. At the end of year 8, the investment has a residual value of $20,000.

The cost of capital is 7.5%.

a. Calculate the NPV for investment A.

Round to the nearest cent

b. Calculate the NPV for investment B.

Round to the nearest cent

c. Which investment should the company choose?

Investment A

Investment B

Niether

Expert Solution

a) Investment A

Calculation of present values of outflows

Year	outflow	[email protected]%	Present Value
0	$60000	1	$60000
3	$50000	0.805	$40250
		Total	$100250

Present Value of total outflows = $100250

Calculation of Present value of inflows

Year	Inflow	PVIF @ 7.5%	Present Value
2	$45000	0.865	38925
3	$45000	0.805	36225
4	$45000	0.749	33705
5	$45000	0.697	31365
6	$45000	0.648	29160
7	$45000	0.603	27135
8	$45000	0.561	25245
8(residual)	$20000	0.561	11220
		TOTAL	232980

Present Values of total inflows=$ 232980

NET PRESENT VALUE(NPV) = Present value of inflows - Present Value of outflows
= 232980 - 100250
=$ 132730

b) INVESTMENT B

Calculation of present value of outflows

Year	Outflow(in $ )	PVIF @7.5%	Present Value (in $)
0	25000	1	25000
1	10000	0.930	9300
2	10000	0.865	8650
3	10000	0.805	8050
		Total	51000

Present value of total ouflows= $ 51000

Calculation of present value of inflows

Year	Inflows (in $)	PVIF @ 7.5%	Present Value (in $)
4	28000	0.749	20972
5	28000	0.697	19516
6	28000	0.648	18144
7	28000	0.603	16884
8	28000	0.561	15708
8(residual)	20000	0.561	11220
		Total	102444

Present Value of total inflows = $ 102444

NET PRESENT VALUE(NPV)= Present value of inflows - Present values of outflow
= 102444 - 51000
= $ 51444

c) Investment A is better than investment B since its NPV is more.

ekkarill92 answered 2 years ago

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