Perit Industries has $180,000 to invest in one of the following two projects: Project A Project BCost of equipment required $ 180,000 $ 0 Working capital investment required $ 0 $ 180,000 Annual cash inflows $ 32,000 $ 54,000 Salvage value of equipment in six years $ 9,300 $ 0 Life of the project 6 years 6 yearsThe working capital needed for project B will be released at the end of six years for investment elsewhere. Perit Industries’ discount rate is 15%.Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using tables.Required:Compute the net present value of Project A.Note: Enter negative values with a minus sign. Round your final answer to the nearest whole dollar amount.Compute the net present value of Project B.Note: Enter negative values with a minus sign. Round your final answer to the nearest whole dollar amount.Which investment alternative (if either) would you recommend that the company accept?
Question
Perit Industries has 180,000 0 32,000 9,300 $ 0 Life of the project 6 years 6 yearsThe working capital needed for project B will be released at the end of six years for investment elsewhere. Perit Industries’ discount rate is 15%.Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using tables.Required:Compute the net present value of Project A.Note: Enter negative values with a minus sign. Round your final answer to the nearest whole dollar amount.Compute the net present value of Project B.Note: Enter negative values with a minus sign. Round your final answer to the nearest whole dollar amount.Which investment alternative (if either) would you recommend that the company accept?
Solution
To answer this question, we need to calculate the Net Present Value (NPV) of both projects. The NPV is the difference between the present value of cash inflows and the present value of cash outflows over a period of time.
Step 1: Calculate the NPV of Project A
The cost of equipment required for Project A is $180,000. This is an outflow, so it's considered as a negative value.
The annual cash inflows are 32,000 * 4.487 = $143,584.
The salvage value of the equipment in six years is 9,300 * 0.432 = $4,018.
So, the NPV of Project A = - 143,584 (PV of cash inflows) + 32,398.
Step 2: Calculate the NPV of Project B
The working capital investment required for Project B is $180,000. This is an outflow, so it's considered as a negative value.
The annual cash inflows are 54,000 * 4.487 = $242,298.
The working capital will be released at the end of six years for investment elsewhere. This is considered as a cash inflow. The present value of this amount can be calculated using the present value of a single sum formula or a present value table. The present value factor for 6 years at 15% is 0.432 (from Exhibit 14B-2). So, the present value of the released working capital is 77,760.
So, the NPV of Project B = - 242,298 (PV of cash inflows) + 140,058.
Step 3: Recommendation
Project B has a higher NPV (32,398). Therefore, I would recommend that the company invest in Project B.
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