Question

Splendid Systems is considering the following three investment opportunities:

Project I would require an immediate cash outlay of $39,000 and would result in cash savings of $8,100 each year for 5 years.
Project II would require cash outlays of $8,000 per year (starting at the end of year 1) and would provide a cash inflow of $41,000 at the end of 5 years.
Project III would require a cash outlay of $35,000 now and would provide a cash inflow of $62,000 at the end of 5 years.

Required:
Use the net present value method to determine which, if any, of the three projects is acceptable.

Answer 1

Missing question: Required The discount rate is 14%. Use the net present value method to determine which, if any of the projects is acceptable.

I. Present value of inflows = $8,100*Present value of annuity factor(14%,5) = $8,100 * 3.433 = $27,807.3

NPV = Present value of inflows - Present value of outflow = $27,807.30 - $39,000 = -$11,192.7

II. Present value of inflows = $40,000*Present value of discounting factor(14%,5) = $40,000/1.14^5 = $40,000/1.9254 = $20,774.90

Present value of outflows = $8,000*Present value of annuity factor(14%,5) = $8,000*3.433 = $27,464

NPV = Present value of inflows - Present value of outflow = $20,774.90 - $27,464 = -$6,689.10

III. Present value of inflows = $62,000*Present value of discounting factor(14%,5) = $62,000/1.14^5 = $62,000/1.9254 = $32,201.10

NPV = Present value of inflows-Present value of outflow = $32,201.10 - $35,000 = -$2,798.90

Conclusion: Option 3 is better by having a higher NPV, but all the projects are acceptable if they are independent.