Question

Axis Corp. is considering an investment in the best of two mutually exclusive projects. Project Kelvin involves an overhaul of the existing system; it will cost $52,500 and generate cash inflows of $30,000 per year for the next 33 years. Project Thompson involves replacement of the existing system; it will cost $260,000 and generate cash inflows of $60,000 per year for 66 years. Using a(n) 10.69% cost of capital, calculate each project's NPV, and make a recommendation based on your findings.

The NPV of project Kelvin is _____$. (Round to the nearest cent.)

The NPV of project Thompson is ____$ (Round to the nearest cent.)

Which project should the company choose?

Answer 1

The NPV of project Kelvin is computed as shown below:

Present value = Initial cost + Annual cash inflow x [ (1 – 1 / (1 + r)ⁿ) / r ]

= - $ 52,500 + $ 30,000 x [ (1 - 1 / (1 + 0.1069)³³ ) / 0.1069 ]

= - $ 52,500 + $ 270,805.8087

= $ 218,305.81 Approximately

The NPV of project Thompson is computed as shown below:

Present value = Initial cost + Annual cash inflow x [ (1 – 1 / (1 + r)ⁿ) / r ]

= - $ 260,000 + $ 60,000 x [ (1 - 1 / (1 + 0.1069)⁶⁶ ) / 0.1069 ]

= - $ 260,000 + $ 560,583.5331

= $ 300,583.53 Approximately

Since the NPV of project Thompson is larger, hence project Thompson shall be accepted.