Dwight Donovan, the president of Stuart Enterprises is considering two investment opportunities. Because of limited resources he will be able to only invest in one of them. Project A is to purchase a machine that will enable factory automation; the machine is expected to have a useful life of five years and no salvage value. Project B supports a training program that will improve the skills of employees operating the current equipment. Initial cash expenditures for Project A are $118,000 and for Project B are $30,000. The annual expected cash inflows are $39,457 for Project A and $8,322 for Project B. Both investments are expected to provide cash flow benefits for the next five years. Stuart Enterprises’ desired rate of return is 6 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required A) Compute the net present value of each project. Which project should be adopted based on the net present value approach? B) Compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach? Net Present Value Project A Project B Internal Rate of Return Project A % Project B %
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Net present value = Present value of cash inflows - Present value of cash outflows
Project A:
Present value of cash inflows = Annual cash inflows x PVIFA @ 6 % 5 years = $39457 * 4.212364 = $166207.25
Present value of cash outflows = Initial investment = $118000
Net present value = $166207 - $118000 = $48207.25
Project B:
Present value of cash inflows = Annual cash inflows x PVIFA = $8322 * 4.212364 = $35055.29
Present value of cash outflows = Initial investment = $30000
Net present value = 35055 - 30000 = $5055.29
| Net Present Value | |
| Project A | 48207.25 |
| Project B | 5055.29 |
| Which project should be adopted? | Project A |
| Net Present Value | |
| Project A | 20% |
| Project B | 12% |
| Which project should be adopted? | Project A |
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