Question

Perit Industries has $155,000 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	$	155,000	$	0
Working capital investment required	$	0	$	155,000
Annual cash inflows	$	25,000	$	40,000
Salvage value of equipment in six years	$	8,600	$	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 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using tables.

Required:

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

Ans:

1)Calculation of Net Present Value for Project A

Particulars	calculation	Amount ($)
Initial Investment	$155,000	(155,000)
PV of Cash inflows (Cash flows * PV Annuity Factor 6years, 14%)	$25,000 * 3.8887	97,217
Terminal Cash flow (Salvage value * PVIF 6years, 14%)	$8,600 *0.4556	3,918
Net Present Value of Project A (PV of cash inflows – initial investment)		(53,865)

2)Calculation of Net Present Value for Project B

Particulars	Working	Amount ($)
Investment Required Working Capital	$155,000	(155,000)
PV of Cash inflows (Cash flows * PV Annuity factor 6years, 14%)	$40,000 * 3.8887	155,548
Terminal Cash flow (Working capital release * PVIF 6years, 14%)	$155,000 *0.4556	70,618
Net Present Value of Project B (PV of cash inflows – initial investment)		71,166

3)

Project B should be Recommended because of positive NPV

Note:

Please check Annuity table once for present value