Exercise 12-14 Comparison of Projects Using Net Present Value [LO12-2]
Labeau Products, Ltd., of Perth, Australia, has $29,000 to invest. The company is trying to decide between two alternative uses for the funds as follows:
Invest in Project X |
Invest in Project Y |
|||
Investment required | $ | 29,000 | $ | 29,000 |
Annual cash inflows | $ | 8,000 | ||
Single cash inflow at the end of 6 years | $ | 60,000 | ||
Life of the project | 6 years | 6 years | ||
The company’s discount rate is 15%.
Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using tables.
Required:
1. Compute the net present value of Project X.
2. Compute the net present value of Project Y.
3. Which project would you recommend the company accept?
Answer :-
1. Computation of the net present value of Project X :-
Net Present Value of Project X = Annual cash inflow - Initial Investment
Net Present Value of Project X = $8,000*(15%, 6 years) - $29,000
Net Present Value of Project X = $8,000*3.78448 - $29,000
Net Present Value of Project X = $1,276
2. Computation of the Net Present Value of Project Y :-
Net Present Value of Project Y = Single cash inflow - Initial Investment
Net Present Value of Project Y = $60,000 *0.43232 - $29,000
Net Present Value of Project Y = ($3,060)
3. Project X should be selected. Project Y does not provide the required 15% return, as shown by its negative net present value.
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