Question

Labeau Products, Ltd., of Perth, Australia, has $34,000 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	$	34,000	$	34,000
Annual cash inflows	$	9,000
Single cash inflow at the end of 6 years			$	60,000
Life of the project	6 years		6 years

The company’s discount rate is 14%.

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

Formula for Net present value = Discounted Inflows - Discounted outflows

1. Net present value of Project X can be calculated as follows:

End of Year	Cash Flow	Present value factor @14%	Discounted Cash Flow
0	(34000)	1	(34000)
1-6	9000	3.8887	35000
Total Inflows			35,000

Net present value = Discounted Inflows - Discounted outflows

= 35,000 - 34000 = $1,000

The net present value of Project X = $1,000.

2. Net present value of Project Y can be calculated as follows:

End of Year	Cash Flow	Present value factor @14%	Discounted Cash Flow
0	(34000)	1	(34000)
6	60,000	0.4556	27336
Total Inflows			27,336

Net present value = Discounted Inflows - Discounted outflows

= 27,336 - 34000 = - $6,664

The net present value of Project Y = - $6,664.

3. It is recommended to invest in project X as the Net present value of Project X is greater than Project Y.