APPLY THE CONCEPTS: Net present value Project A This project requires an initial

Question

APPLY THE CONCEPTS: Net present value

Project A
This project requires an initial investment of $173,250. The project will have a life of 4 years. Annual revenues associated with the project will be $90,000 and expenses associated with the project will be $40,000 for an annual net cash flow of $.

Note: Enter cash flows as positive numbers.

Project B
This project requires an initial investment of $63,400. The project will have a life of 4 years. Annual revenues associated with the project will be $90,000, and expenses associated with the project will be $70,000, for an annual net cash flow of $.

The cost of capital for the company is 7%.

Use the minus sign to indicate a negative NPV. If an amount is zero, enter"0".

Based upon net present value, which project has the more favorable profit prospects?

Cash Flows Year 0 -$173,250 Year 1 Year 2 Year 3 Year 4

Explanation / Answer

PROJECT A

PROJECT B

COST OF CAPITAL=7%

NPV OF PROJECT A=PRESENT VALUE OF CASH INFLOWS-INITIAL INVESTMENT

=$50,000 PVIFA(7%,4)-$173,250

=$50,000*3.387-$1,73,250

=$1,69,350-$1,73,250

= - $ 3,900

NPV OF PROJECT B=PRESENT VALUE OF CASH INFLOWS-INITIAL INVESTMENT

=$20,000PVIFA(10%,4)-$63,400

=$20,000*3.387-$63,400

=$67,740-$63,400

=$4,340

BASED UPON NET PRESENT VALUE PROJECT B HAS MORE FAVOURABLE PROFIT PROSPECTS HAVING A POSITIVE NPV OF $4,340

YEAR NET CASH FLOW($) 0 -$173,250 1 $90,000-$40,000=$50,000 2 $50,000 3 $50,000 4 $50,000

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