Question

Net Present Value Analysis
Hermson Company must evaluate two capital expenditure proposals. Hermson's cutoff rate is 12%. Data for the two proposals follow.

	Proposal X	Proposal Y
Required investment	$280,000	$280,000
Annual after-tax cash inflows	66,000
After-tax cash inflows at the end of years 3, 6, 9, and 12		198,000
Life of project	12 years	12 years

Using net present value analysis, which proposal is the more attractive?
Do not use negative signs with your answers. Round PV answers to the nearest whole number. Use rounded answers for subsequent calculation of net present value.

	Proposal X	Proposal Y
Net present value
Initial outflows	$Answer	$Answer
PV of future cash flows	Answer	Answer
Net present value	$Answer	$Answer

Answer 1

Solution:

Computation of NPV - Hermson Company - Proposal X
Particulars	Period	Amount	PV Factor	Present Value
Cash Outflows:
Initial Outflows	0	$280,000	1	$280,000
Present value of cash outflows (A)				$280,000
Cash Inflows:
Annual net cash inflows	1-12	$66,000	6.194	$408,828
PV of Future cash Flows (B)				$408,828
NPV (B-A)				$128,828

Computation of NPV - Hermson Company - Proposal Y
Particulars	Period	Amount	PV Factor	Present Value
Cash Outflows:
Initial Outflows	0	$280,000	1	$280,000
Present value of cash outflows (A)				$280,000
Cash Inflows:
Year 3	3	$198,000	0.71178	$140,932
Year 6	6	$198,000	0.50663	$100,313
Year 9	9	$198,000	0.36061	$71,401
Year 12	12	$198,000	0.25668	$50,823
PV of Future cash Flows (B)				$363,469
NPV (B-A)				$83,469