Question

JJ Industries has $150,000 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 $ 150,000 $ 0 Working capital investment required $ 0 $ 150,000 Annual cash inflows $ 24,000 $ 37,000 Salvage value of equipment in six years $ 8,500 $ 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 15%. 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

COMPUTATION OF NPV OF PROJECT A

NPV = (Present value of cash inflow+prsent value of salvage value - initial investment)

STEP1:-

computation of pv of cash inflow + pv of salvage value

=(cash flow* AF@15%,6years)+(salvage value*Pv@15%,6year)

=(24000*3.7845)+(8500*0.4323)=90828+3674=$94502

STEP2:-

INITIAL INVESTMENT=$150,000

NPV = (STEP1-STEP2)=$(94502-150,000)= - 55498

CONCLUSION- NEGATIVE NPV.

COMPUTATION OF NPV OF PROJECT B:-

STEP1:-

computation of pv of cash inflow + pv of salvage value+ PV value of working capital at the end of 6th year

=(cash flow* AF@15%,6years)+(salvage value*Pv@15%,6year)+(working capital*Pv@15%,6year)

=(37000*3.7845)+(8500*0.4323)+(150,000*0.4323)=$(140,026+3674+64845)=$208,545

STEP2:-

INITIAL INVESTMENT=$150,000

NPV = (STEP1-STEP2)=(208,545-150,000)=$58,545

CONCLUSION:- Positive Npv

RECOMENDATION:-

PROJECT B SHOULD BE ACCEPTED BECASUE OF POSITIVE NPV.