Question

Perit Industries has $100,000 to invest. The company is trying to decide between two alternative uses of the funds. The alternatives are:

	Project A		Project B
Cost of equipment required	$	100,000	$	0
Working capital investment required	$	0	$	100,000
Annual cash inflows	$	21,000	$	16,000
Salvage value of equipment in six years	$	8,000	$	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 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.

Required:

1. Compute the net present value of Project A. (Enter negative values 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 values 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

1) Net Present Value of Project A = $ -14,693
PROJECT A - NET PRESENT VALUE
Year	Equipment Cost	Annual Cash Inflows	Salvage value	Total Cashflow	PVF/PVAF	Net Present Value
0	-100,000	-	-	-100,000	1	-100,000
1-6	-	21,000	-	21,000	3.8887	81,663
6	-	-	8,000	8,000	0.4556	3,645
						-14,693
2) Net Present Value of Project B = $ 7,779
PROJECT B - NET PRESENT VALUE
Year	Working Capital Investment	Annual Cash Inflows	Total Cashflow	PVF/PVAF	Net Present Value
0	-100,000	-	-100,000	1	-100,000
1-6	-	16,000	16,000	3.8887	62,219
6	100,000	-	100,000	0.4556	45,560
					7,779
3) I would recommend the company to accept Project B since it gives a higher Net Present Value.
Also, the company should never invest in Project A since it leads to a negative present value of cashflows.