Question

Dwight Donovan, the president of Campbell Enterprises, Is considering two Investment opportunitles. Because of limited resources, he will be able to Invest in only one of them. Project A Is to purchase a machine that will enable factory automation; the machine is expected to have a useful life of five years and no salvage value. Project B supports a training program that will improve the skills of employees operating the current equipment Initial cash expenditures for Project A are $101,000 and for Project B are $44,000. The annual expected cash infiows are $25.966 for Project A and $12,816 for Project B. Both Investments are expected to provide cash flow benefits for the next five years. Campbell Enterprises cost of capital is 8 percent (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a. Compute the net present value of each project. Which project should be adopted based on the net present value approach? b. Compute the approximate Internal rate of retarn of each project. Which one should be adopted based on the Internal rate of return approach?

Answer 1

Required A Project A- $2,674

Project B- 7,170

*So project B is preferable as higher net present value.

Project A net present value= Present value of inflow - Present value of outflow

=($25,966*3.99271)-$101,000

=$2,674

Project B net present value= Present value of inflow - Present value of outflow

=($12,816*3.99271)-$44,000

=$7,170

Required B Project A- 9%

Project B-14%

*So project B is preferable as higher Internal rate of return.

Project A internal rate of return:-

Present value of inflow=Present value of outflow

($25,966 * X)=$101,000

X=3.8897 which is the present value factor of 9%

Project B internal rate of return:-

Present value of inflow=Present value of outflow

($12,816 * X)=$44,000

X=3.4332 which is the present value factor of 14%