Question

Labeau Products, Ltd., of Perth, Australia, has $26,000 to invest. The company is trying to decide between two alternative uses for the funds as follows:

	Invest in Project X		Invest in Project Y
Investment required	$	26,000	$	26,000
Annual cash inflows	$	8,000
Single cash inflow at the end of 6 years			$	50,000
Life of the project	6 years		6 years

The company’s discount rate is 12%.

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.

Required:

1. Compute the net present value of Project X.

2. Compute the net present value of Project Y.

3. Which project would you recommend the company accept?

Answer 1

Answer:

1. Computation of the net present value of an investment in project X:

Particulars	Period	PV Factor@12%	Amount	Present Value
Cash Inflow:
Annual cash inflows	1-6 years	4.1114	$8,000	$32,891
Total cash inflow (a)				$32,891
Cash Outflow:
Initial investment	0 years	1	$26,000	$26,000
Total Cash Outflow (b)				$26,000
Net present Value (a-b)				$6,891

2. Computation of the net present value of an investment in project Y:

Particulars	Period	PV Factor@12%	Amount	Present Value
Cash Inflow:
Single cash inflow at the end of 6 years	6 years	0.5066	$50,000	$25,330
Total cash inflow (a)				$25,330
Cash Outflow:
Initial investment	0 years	1	$26,000	$26,000
Total Cash Outflow (b)				$26,000
Net present Value (a-b)				($670)

3. Project X net present value is positive i.e. $6,891 as compared to Project Y whose NPV is negative $670 & therefore Company should accept project X.