EXERCISE 13-8 Comparison of Projects Using Net Present Value Labeau Products, Lt

Question

EXERCISE 13-8 Comparison of Projects Using Net Present Value
Labeau Products, Ltd., of Perth, Australia, has $35,000 to invest. The company is trying to decide between two alternative uses for the funds as follows:
Invest in Invest in
Project X Project Y
Investment required $35,000 $35,00
Annual cash inflows . $9,000.
Single cash inflow at the end of 10 years . 150,000
Life of the project . 10 years 10 Years

The company's discount rate is 18%.

Required:
(Ignore income taxes.) Which alternative would you recommend that the company accept? Show all computationsusing the net present value approach. Prepare separate computations for each project.

Explanation / Answer

1.Proj X : CF0 = -35000, CF1 to Cf10 =PMT = $9000 pa, i=18%, n=10 NPV = CF0 + PVoA of PMT=$9000 for n=10Yrs at i=18% PVoA = PMT [(1 - (1 / (1 + i)^n)) / i] Where: PVoA = Present Value of an Ordinary Annuity PMT = Amount of each payment i = Discount Rate Per Period n = Number of Periods ie PVoA = 9000*[(1 - (1/(1+18%)^10))/18%] ie PVoA = 9000*{(1 - 0.1911)/18%} = 40446.78 So NPV = -35000+40446.78 = 5446.78...................Proj X Proj Y: CF0 = -35000, CF10=FV = 150000, i=18%, n=10yrs So PV = FV/(1+i)^n = 150000/(1+18%)^10 = 28659.67 So NPV = CF0+PV = -35000+28659.67 = -6340.33.....Proj Y So Proj X is better as it has a positive NPV

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