Question

Perit Industries has $130,000 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	$	130,000	$	0
Working capital investment required	$	0	$	130,000
Annual cash inflows	$	21,000	$	65,000
Salvage value of equipment in six years	$	8,100	$	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 17%.

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

Solution:

1. NPV of project A

= - cost + annual cash inflow x APVF + Salvage value x PVF

= -130,000 + 21,000 x 3.58918 + 8100 x 0.38984

= -130,000 + 75,372.78 + 3,157.70

= - $51,469.52 ( rounded off as $51,470)

2. NPV of project B

= working capital + annual cash inflow x APVF + working capital x PVF

= -130,000 + 65,000 x 3.58918 + 130,000 x 0.38984

= -130,000 + 233,296.70 + 50,679.20

= $153,976

3. We should recommend project B as it has positive net present value.