Question

Labeau Products, Ltd., of Perth, Australia, has $35,000 to invest. The company is trying to decide between two alternative uses for the funds as follows:

Invest in
Project X
Investment required $ 35,000
Annual cash inflows $12,000
Life of the project 6 years
Invest in
Project Y
Investment required $ 35,000
Single cash inflow at the end of 6 years $90,000
Life of the project 6 years
The companys discount rate is 18%.

Required:

a. Determine the net present values. (Any cash outflows should be indicated by a minus sign. Round discount factor(s) to 3 decimal places.)

Answer 1

The net present value (NPV) of Project X is $6,964, indicating a positive return on the investment, while the NPV of Project Y is -$4,670, indicating that the investment would not return the initial outlay.

Step-by-step explanation:

To determine the net present values (NPVs) of Project X and Project Y, we use the discount rate of 18%. The NPV is calculated by discounting the expected cash flows from a project back to their present value using the discount rate and then subtracting the initial investment. For Project X, which promises annual cash inflows of $12,000 for 6 years, we must calculate the present value of an annuity.

The NPV of Project X is then $41,964 - $35,000 = $6,964. For Project Y, there is a single cash inflow of $90,000 at the end of 6 years. To find its present value, we use the present value of a single sum formula PV = FV / (1 + r)^n, where FV is the future value. The present value of the $90,000 cash inflow at an 18% discount rate over 6 years is $90,000 × 0.337 = $30,330. The NPV of Project Y is therefore $30,330 - $35,000 = -$4,670.