Professor Upton is evaluating two projects for a client. Project A Project B Ori

Question

Professor Upton is evaluating two projects for a client.

                                                            Project A                     Project B

Original Cost                           $250,000                     $235,000

Increase in Revenue/yr            $110,000                     $125,000

Labor Cost/yr                          $ 26,000                      $ 35,000

Material Cost/yr                     $ 12,000                      $ 24,000

Overhead Depreciation           $ 25,000                      $ 45,000

a) All cost figures are cash outlays, except the overhead charge which is an accounting entry. Both projects have lifespan of 5 yrs. If the company wants to use an 11% rate of return, which project should Professor Upton recommend?

b) Suppose Project A has a salvage value of $5,000; Project b $20,000. Does your answer in part a change?

Explanation / Answer

1) Select Project A as the NPV is higher than Project B Project A 0 1 2 3 4 5 Cost (250,000.00) Inc in Revenue 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 Labor Cost (26,000.00) (26,000.00) (26,000.00) (26,000.00) (26,000.00) Mat Cost / yr (12,000.00) (12,000.00) (12,000.00) (12,000.00) (12,000.00) Total Net Cash Flows (250,000.00) 72,000.00 72,000.00 72,000.00 72,000.00 72,000.00 Interest Rae 11% NPV 16,104.59 Project B 0 1 2 3 4 5 Cost (235,000.00) Inc in Revenue 125,000.00 125,000.00 125,000.00 125,000.00 125,000.00 Labor Cost (35,000.00) (35,000.00) (35,000.00) (35,000.00) (35,000.00) Mat Cost / yr (24,000.00) (24,000.00) (24,000.00) (24,000.00) (24,000.00) Total Net Cash Flows (235,000.00) 66,000.00 66,000.00 66,000.00 66,000.00 66,000.00 Interest Rae 11% NPV 8,929.20

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