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	$	20,000	$	55,000
Salvage value of equipment in six years	$	9,400	$	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 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using tables.

Required:

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

Answer
1
Net present value (NPV):
Project A		PVA
Annual cash inflows	$ 20,000	3.889	$     77,780
Salvage value of equipment in six years	$    9,400	0.456	$       4,286
Less- Outflow			-$   155,000
Net present value			-$     72,934
2
Net present value (NPV):
Project B		PVA
Annual cash inflows	$ 55,000	3.889	$   213,895
Salvage value of equipment in six years	$155,000	0.456	$     70,680
Less- Outflow			-$   155,000
Net present value			$   129,575
3
Project B should be choosen.
**
Present value of annuity at 14% for 6 years = 3.889
Present value factor at 14% for 6th year = 0.456