Valley Products,Inc, is considering two independent investments having the follo

Question

Valley Products,Inc, is considering two independent investments having the following cash flow streams:

Year Project A Project B
0 -$50,000 -$40,000
1 +$20,000 +$20,000
2 +$20,000 +$10,000
3 +$10,000 +$ 5,000
4 +$ 5,000 +$ 5,000
5 +$ 5,000 +$40,000

Valley uses a combination of the net present value approach and the payback approach to evaluate investment alternatives. It requires that all projects have a positive net present value when cash flows are discounted at 10 percent and that all projects have a payback no longer than three years. Which project or projects should the firm accept? Why?

Explanation / Answer

If NPV is the crietrion then Project B will be selected as it is greater then project A.

If Pay back is the criterion then Project A = 3 years will be selected.

Year Project A Project B PVIF10% PV of Project A PV of Project B 0 -$50,000 -$40,000 1 -$50,000.00 -$40,000.00 1 $20,000 $20,000 0.909 $18,181.82 $18,181.82 2 $20,000 $10,000 0.826 $16,528.93 $8,264.46 3 $10,000 $5,000 0.751 $7,513.15 $3,756.57 4 $5,000 $5,000 0.683 $3,415.07 $3,415.07 5 $5,000 $40,000 0.621 $3,104.61 $24,836.85 NPV -$1,256.43 $18,454.78

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