In: Accounting
Labeau Products, Ltd., of Perth, Australia, has $12,000 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 | $ | 12,000 | $ | 12,000 |
Annual cash inflows | $ | 4,000 | ||
Single cash inflow at the end of 6 years | $ | 28,000 | ||
Life of the project | 6 years | 6 years | ||
The company’s discount rate is 16%.
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?
Note - in Exhibit 13B-1 and Exhibit 13B-2 table, Factor values are given upto 3 decimals so i have used it. Answer may be differ if used values upto 4 or 5 decimals.
1. Calculation of Net Present Value of Project X
Initial Investment = $12,000
Annual Cash Inflow = $4,000
Present Value Annuity Factor @16% for 6 Years, PVAF(6, 16%) = 3.685
Present Value (PV) of Cash Inflow = PVAF(6, 16%) x Annual Cash
Inflow
= 3.685 x $4,000
= $14740
Net Present Value of Project X = Present
Value of Cash Inflow – Initial Investment
= $14740 – 12,000
= $2740
2. Calculation of Net Present Value of Project Y
Initial Cash Outflow = $12,000
Cash Inflow at the end of 6 Year = $28,000
Present Value @16% of 6th year, PVF(6, 16%) = 0.410
Present Value of Cash Inflow = PVF(6, 16%) * Cash Inflow at end of
6th year
= 0.410 * $28,000
= $11,480
Net Present Value of Project Y = Present
Value of Cash Inflow – Initial Investment
= $11,480 – 12,000
= ($520)
NPV of Project Y = ($520)
C)
As Project X have povitive Net Present Value, so Project X should be Accepted