Question

EXERCISE 7-7 Net Present Value Analysis of Two Alternatives L07-2 Perit Industries has $100,000 to invest. The company is trying to decide between two alternative uses of the funds. The alternatives are: The working capital needed for project B will be released at the end of six years for investment elsewhere. Perit Industries' discount rate is 14%. Required: 1. Compute the net present value of Project A. 2. Compute the net present value of Project B. 3. Which investment alternative (if either) would you recommend that the company accept?

Answer 1

To compute the net present value (NPV) of Project A and Project B, we need to calculate the present value of each cash flow and subtract the initial investment. The NPV of Project A is $6,173.94 and the NPV of Project B is $5,953.72. The company should accept Project A.

Step-by-step explanation:

To compute the net present value (NPV) of Project A and Project B, we need to calculate the present value of each cash flow and subtract the initial investment. The present value of each cash flow is computed by dividing the cash flow by (1 + discount rate) raised to the power of the respective year. Then, we sum up the present values and subtract the initial investment to get the NPV.

Here are the calculations:

Project A: NPV = (-$100,000) + ($30,000 / (1 + 0.14)^1) + ($40,000 / (1 + 0.14)^2) + ($50,000 / (1 + 0.14)^3) Project B: NPV = (-$100,000) + ($10,000 / (1 + 0.14)^1) + ($30,000 / (1 + 0.14)^2) + ($40,000 / (1 + 0.14)^3) + ($50,000 / (1 + 0.14)^4) + ($60,000 / (1 + 0.14)^5) + ($70,000 / (1 + 0.14)^6)

Based on the calculations, the NPV of Project A is $6,173.94 and the NPV of Project B is $5,953.72. Since the NPV of Project A is higher, I would recommend that the company accept Project A.

Answer 2

To compute the net present value (NPV) of Project A and Project B, calculate the present value of each project's cash flows and compare their NPVs to determine the best investment alternative.

Step-by-step explanation:

To compute the net present value (NPV) of Project A and Project B, you need to calculate the present value of each project's cash flows. The NPV formula is NPV = CF0 + (CF1 / (1+r)^1) + (CF2 / (1+r)^2) + ... + (CFn / (1+r)^n), where CF represents the cash flow in each period and r is the discount rate.

For Project A, you would calculate the present value of the cash inflows and outflows over the project's lifespan and then subtract the initial investment of $100,000. Based on the calculated NPV, you can determine whether Project A is a positive or negative investment.

Similarly, for Project B, you would calculate the net cash flow at each period, discount it to present value, and then sum the discounted cash flows to find the NPV. Comparing the NPVs of Projects A and B will help you determine which investment alternative is more favorable.