In: Accounting
Exercise 13-14 Comparison of Projects Using Net Present Value [LO13-2]
Labeau Products, Ltd., of Perth, Australia, has $18,000 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 | $ | 18,000 | $ | 18,000 |
Annual cash inflows | $ | 7,000 | ||
Single cash inflow at the end of 6 years | $ | 41,000 | ||
Life of the project | 6 years | 6 years | ||
The company’s discount rate is 17%.
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?
( 1 ) -- Compute the net present value of Project X.
Answer -
Calculation of Net Present Value of Project X
Particulars | Formula used | Calculation | Present Value ($) | |
Initial investment | - | Given in question | (18000) | |
Annual cash inflows (years 1 to 6) |
p = Annual cash inflow = $7000 r = Discount rate = 17% n = Number of annual cash inflow = 6 |
$7000[1-(1+0.17)-6/0.17] | 25124 | |
Net Present Value |
$25124 - $18000 | 7124 | ||
.
( 2 ) -- Compute the net present value of Project Y.
Answer -
Calculation of Net Present Value of Project Y
Particulars | Formula used | Calculation | Present Value ($) | |
Initial investment | - | - | (18000) | |
Single cash inflow at the end of 6th year |
C = cash inflow at the end = $41000 r = Discount rate = 17% n = 6 years |
$41000 / (1+0.17)6 | 15983 | |
Net Present Value |
$15983 - $18000 | (2017) | ||
.
( 3 ) -- Which project would you recommend the company accept?
Answer -
Project X should be selected, Project Y does not provide the required 17% return, as shown by its negative Net present value.