Question

Project A		Project B
Cost of equipment required	$	155,000	$	0
Working capital investment required	$	0	$	155,000
Annual cash inflows	$	25,000	$	40,000
Salvage value of equipment in six years	$	8,600	$	0
Life of the project		6 years		6 years

The working capital needed for project B will be released at the end of six years for investment elsewhere. Perit Industries’ discount rate is 14%.

Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using tables.

Required:

1. Compute the net present value of Project A. (Enter negative value with a minus sign. Round your final answer to the nearest whole dollar amount.)

2. Compute the net present value of Project B. (Enter negative value with a minus sign. Round your final answer to the nearest whole dollar amount.)

3. Which investment alternative (if either) would you recommend that the company accept?

Answer 1

NPV is difference between present value of cash flows and initial investment.

Discount factors are used to find present value.

When there is uniform series of cash flows than we will use PV annuity table.

Project A

Year	Cash flows	PV factor of $1 14%	Present value of cash flows
0	($155,000)	1	($155,000)
1-6	$25,000	3.88867	$97,216.75[$25,000*3.88867]	use 12B 2
6	$8,600	0.456	$3,921.6[$8,600*0.456]	single cash flow so use 12B 1
		NPV	-$53,862

NPV is -$53,862

Project B

Year	Cash flows	PV factor of $1 14%	Present value of cash flows
0	($155,000)	1	($155,000)
1-6	$40,000	3.88867	$155,546.8[$40,000*3.88867]	use 12B 2
6	$155,000	0.456	$70,680[$155,000*0.456]	single cash flow so use 12B 1(workin capital released)
		NPV	$71,227

NPV is $71,227

3.Project should be selected only if NPV is positive i.e PV of cash inflows> initial investmnet

Project B should be selected as it NPV is positive.