Question

Labeau Products, Ltd., of Perth, Australia, has $26,000 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 $ 26,000 $ 26,000 Annual cash inflows $ 7,000 Single cash inflow at the end of 6 years $ 50,000 Life of the project 6 years 6 years The company’s discount rate is 12%. 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?

Answer 1

Net present value of project x;

present value of cash out flows = $26,000.

present value of cash inflows = $7000* present value of annuity factor for 12% at 6 years.

=>7000*[(1+r)^(-n)-1]/r

here,

r= 12% =>0.12.

n=6.

=>7000*[(1.12)^(-6)-1]/0.12

=>7000*[0.4933689/0.12]

=>7000*4.1114075

=>$28,779.85.

Net present value = present value of cash inflows - present value of cash outflows

=>28,779.85 - 26,000

=>$2,779.85.

project y;

present value of cash outflows =26,000

present value of cash inflow = 50,000* present value factor @12% for 6 th year

=>50,000*1/(1+r)^n

=>50,000*1/(1.12)^6

=>$25,661.56.

Net present value = 25,661.56-26,000

=>-$338.44

project X shall be accepted since it has a positive NPV.