Question

Use the NPV method to determine whether Salon Products should invest in the following​ projects: Project A costs $290,000 and offers seven annual net cash inflows of $64,000. Salon Products requires an annual return of 12% on projects like A. Project B costs $390,000 and offers ten annual net cash inflows of $74,000. Salon Products demands an annual return of 14% on investments of this nature. What is the NPV of each​ project? What is the maximum acceptable price to pay for each​ project? Please explain.

Answer 1

Project A:

Cost of Project = $290,000
Annual Cash Inflows = $64,000
Annual Return = 12%
Period = 7 years

Present Value of Cash Inflows = $64,000 * PVIFA(12%, 7)
Present Value of Cash Inflows = $64,000 * (1 - (1/1.12)^7) / 0.12
Present Value of Cash Inflows = $64,000 * 4.56376
Present Value of Cash Inflows = $292,081

Net Present Value = Present Value of Cash Inflows - Cost of Project
Net Present Value = $292,081 - $290,000
Net Present Value = $2,081

Maximum amount paid for Project A is $292,081

Project B:

Cost of Project = $390,000
Annual Cash Inflows = $74,000
Annual Return = 14%
Period = 10 years

Present Value of Cash Inflows = $74,000 * PVIFA(14%, 10)
Present Value of Cash Inflows = $74,000 * (1 - (1/1.14)^10) / 0.14
Present Value of Cash Inflows = $74,000 * 5.21612
Present Value of Cash Inflows = $385,993

Net Present Value = Present Value of Cash Inflows - Cost of Project
Net Present Value = $385,993 - $390,000
Net Present Value = -$4,007

Maximum amount paid for Project B is $385,993