Perit Industries has $200,000 to invest. The company is trying to decide between

Question

Perit Industries has $200,000 to invest. The company is trying to decide between two alternative uses of the funds. The alternatives are: Project AProject B $0 $0 $200,000 $51,000 $0 6 years S200,000 Cost of equipment required Working capital investment required Annual cash inflows Salvage value of equipment in six years Life of the project $29,000 $9,000 6 years The working capital needed for project B will be released at the end of six years for investment elsewhere. Pent Industries' discount rate is 14% Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables Required a. Calculate net present value for each project. Project A Project B Net t present value

Explanation / Answer

Cost of Project A = Cost of Equipment + Working Capital Required

= $200,000 + $0 = $200,000

Present Value Of Cash Flows = PV of annual Cashflows + Salvage value

= 29,000 (PVAF @ 14% for 5 years) + (29,000 +9,000) * PVF @14% for 6 years

= (29,000 *3.4331) + (38,000 * 0.456) = 99,560 + 17,328 =  $116,888

NPV of Project A = 116,888 - 200,000 = (83,112)

Cost of Project B = Cost of Equipment + Working Capital Required

= $0 + $200,000 = $200,000

Present Value of Cash Flows = PV of annual Cashflows + Salvage Value

= 51,000 (PVAF @ 14% for 6 years) + 0

= 51,000 * 3.8887 = 198,323

NPV of Project B = 198,323 - 200,000 = (1,677)

So, NPV of Project B is higher and hence it should be selected.

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