Perit Industries has 135000 to invest The company is trying

Perit Industries has $135,000 to invest. The company is trying to decide between two alternative uses of the funds. The alternatives are Project A Project B $135,000 $ Cost of equipment required Working capital investment required Annual cash inflows Salvage value of equipment in six years Life of the project 0 $135,000 $ 22,000 66,000 $ 8,400 $ 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 17% 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? 1. Net present value project A 2. Net present value project B Which investment alternative (if either) would you recommend that the company accept?

Solution

Solution:

Net Present Value

Net Present Value is the difference of Present Value of all future expected cash Inflows and Present Value of Initial Investment or Cash Outflows.

Present Value is calculated by using a discounting rate which is 17% in the given question.

Net Present Value of Project A

Particulars

Year

0

1

2

3

4

5

6

Cost of equipment required

(this cash outflow/cost is needed immediately i.e. today i.e. Year 0)

($135,000)

Annual Cash Inflows

$22,000

$22,000

$22,000

$22,000

$22,000

$22,000

Salvage Value of Equipment in Year 6

$8,400

Total Cash Flows (A)

($135,000)

$22,000

$22,000

$22,000

$22,000

$22,000

$30,400

PV factor @ 17% (B)

1

0.855

0.731

0.625

0.534

0.456

0.390

Present Value of Cash Flows (A*B)

-$135,000

$18,810

$16,082

$13,750

$11,748

$10,032

$11,856

Net Present Value

(Sum of Present Value of Cash Flows)

-$52,722

Net Present Value of Project A is -$52,722

Net Present Value of Project B

We need to understand the treatment of Working Capital required in Investment. Working Capital is the amount of cash needed to operate day to day working. It is treated as Outflow at the initial period of the project since we need to spent the working capital amount at year 0 and at the end of the project life this amount is released from the project as an Cash Inflow.

Particulars

Year

0

1

2

3

4

5

6

Cost of equipment required

$0

Working Capital Investment Required

($135,000)

Annual Cash Inflows

$66,000

$66,000

$66,000

$66,000

$66,000

$66,000

Salvage Value of Equipment in Year 6

$0

Working Capital Released at the end of year 6

$135,000

Total Cash Flows (A)

($135,000)

$66,000

$66,000

$66,000

$66,000

$66,000

$201,000

PV factor @ 17% (B)

1

0.855

0.731

0.625

0.534

0.456

0.390

Present Value of Cash Flows (A*B)

-$135,000

$56,430

$48,246

$41,250

$35,244

$30,096

$78,390

Net Present Value

(Sum of Present Value of Cash Flows)

$154,656

Net Present Value of Project B is $154,656

1) Net Present Value of Project A = -$52,722

2) Net Present Value of Project B = $154,656

3)The company should accept Project B since it has higher and Positive Net Present Value.

Hope the above calculations, working and explanations are clear to you and help you in understanding the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you

Particulars	Year
0	1	2	3	4	5	6
Cost of equipment required (this cash outflow/cost is needed immediately i.e. today i.e. Year 0)	($135,000)
Annual Cash Inflows		$22,000	$22,000	$22,000	$22,000	$22,000	$22,000
Salvage Value of Equipment in Year 6							$8,400
Total Cash Flows (A)	($135,000)	$22,000	$22,000	$22,000	$22,000	$22,000	$30,400
PV factor @ 17% (B)	1	0.855	0.731	0.625	0.534	0.456	0.390
Present Value of Cash Flows (A*B)	-$135,000	$18,810	$16,082	$13,750	$11,748	$10,032	$11,856
Net Present Value (Sum of Present Value of Cash Flows)	-$52,722