Question

Perrot Industries has $325,000 to invest. The company is trying to decide between two alternative uses of the funds. The alternatives follow:

	Project
	A			B
Cost of equipment required	$	280,000			—
Working capital investment required		—		$	280,000
Annual cash inflows		69,150			57,400
Salvage value of equipment in six years		22,400			—
Life of the project		8 years			8 years

The working capital needed for project B will be released at the end of eight years for investment elsewhere. Perrot Industries’ discount rate is 13%.

Click here to view Exhibit 10-1 and Exhibit 10-2, to determine the appropriate discount factor(s) using tables.

Required:

1-a. Calculate net present value for each project. (Negative amount should be indicated with a minus sign. Round discount factor(s) to 3 decimal places. Round other intermediate calculations and final answers to the nearest whole number.)

1-b. Which investment alternative (if either) would you recommend that the company accept?

multiple choice

• Project A

• Project B

Answer 1

1(a),

year	Annual cash flow for project A, (a)	PV factor @13% (b)	Discounted inflow (A), a*b	Annual cashflow for project B, (d)	PV factor @13%, (e)	Discounted Inflow (B), d*e
0	280000	1	(280000)	280000	1	(280000)
1	69150	0.8849	61191	57400	0.8849	50793
2	69150	0.7831	54151	57400	0.7831	44950
3	69150	0.6930	47921	57400	0.6930	39778
4	69150	0.6133	42410	57400	0.6133	35203
5	69150	0.5427	37528	57400	0.5427	31151
6	69150	0.4803	33213	57400	0.4803	27569
7	69150	0.4250	29389	57400	0.4250	24395
8	69150	0.3761	26007	57400	0.3761	21588

1(b),

NPV= PV of annual cash flow for 8 years -- cost of investment

NPV(A)=331810-280000=51810

NPV(B)=275427-280000=(4573)

Since NPV of project is positive, Project A is preferrable.

note: Decimals are rounded off to the nearest value.

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