Question

Perit Industries has $125,000 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	$125,000	$0
Working capital investment required	$0	$125,000
Annual cash inflows	$23,000	$71,000
Salvage value of equipment in six years	$8,900	$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 15%.

  

Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables.

  

Required:

a.	Calculate net present value for each project.

Answer 1

Net Present Value (NPV) - Project - A

	Cash Flow	Present Value Factor (15%)	Present Value
Cost of equipment required	($125,000)	1.0000	($125,000 )
Annual cash inflows (For 6 Year)	$23,000	3.78448	$87,043
Add : Salvage Value (6th year)	$8,900	0.43233	$3,848
Net Present Value			($34109)

Net Present Value Project A = - $34,109 (Negative )

Net Present Value (NPV) - Project - B

	Cash Flow	Present Value Factor (15%)	Present Value
Working capital investment required	($125,000)	1.0000	($125,000)
Annual cash inflows	$71,000	3.78448	$2,68,698
Add: Working Capital Release (6th Year)	$1,25,000	0.43233	$54,041
Net Present Value			$1,97,739

Net Present Value Project B = $1,97,739 (Positive)