Question

Perit Industries has $175,000 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 $ 175,000 $ 0
Working capital investment required $ 0 $ 175,000
Annual cash inflows $ 27,000 $ 44,000
Salvage value of equipment in six years $ 8,800 $ 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 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.

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

1.NPV of project A= $(69,014.48)

2.NPV of project B= $67,174.56

3.Project B should be accepted because it produces a positive NPV and would increase the wealth of the shareholders

Step-by-step explanation:

The Net present value (NPV) is the difference between the Present value (PV) of cash inflows and the PV of cash outflows. A positive NPV implies a good and profitable investment project and a negative figure implies the opposite.

NPV = PV of cash inflows - PV of cash outflows

PV of cash inflow= A × (1- (1+r)^(-n)/r

A-annul cash inflow, r- discount rate-15%

NPV of project A

Net present value of project A=

PV of cash inflow = 27,000× (1- 1.15^(-6)/0.15= 102,181.0327

PV of salvage value = $ 8,800 × 1.15^(-6)= 3804.482844

NPV = 102,181.0327 + 3804.482844 - 175,000= (69,014.48)

NPV = $(69,014.48)

NPV of Project B

PV of cash inflow = 44,000× (1- 1.15^(-6)/0.15= 166,517.2385

PV of working capital recouped = $175000 × 1.15^(-6)=75,657.32928

NPV = 166,517.23 + 75,657.32 - 175,000 = 67,174.56

NPV = $67,174.56

Recommendation

Project B should be accepted because it produces a positive NPV and would increase the wealth of the shareholders