1. The NPV of project A is $86,720, while the NPV of project B is $23,750.
2. Based on the total NPV, the company should prefer project A to project B if they are exclusive.
The net present value (NPV) refers to the difference between the present value of cash inflows and the present value of cash outflows for a stated project or investment.
Project A:
Initial cost = $800,000
Annual net cash inflows = $170,000
Opportunity cost of capital = 14%
Number of years for the annual cashflows = 10 years
Annuity factor of 14% for 10 years = 5.216
PV annuity of $170,000 = $886,720 ($170,000 x 5.216)
Net Present Value (NPV) = $86,720 ($886,720 - $800,000)
Project B:
Cost of Machine = $380,000
Cost of capital = 12%
Present Value of Cash inflows:
Period Cashflows PV factor Present Value
Year 1 $50 0.893 $44.65
Year 2 $57 0.797 $45.43
Year 3 $75 0.712 $53.40
Year 4 $80 0.636 $50.88
Year 5 $85 0.567 $48.20
Year 6 $92 0.507 $46.64
Year 7 $92 0.452 $41.58
Year 8 $80 0.404 $32.32
Year 9 $68 0.361 $24.55
Year 10 $50 0.322 $16.10
Total present value = $403.75
Net present value = $23,750 (403,750 - $380,000)
Question Completion:
What is the NPV of each project? Which project should the company proceed with?