Question

Dwight Donovan, the president of Finch Enterprises, is considering two investment opportunities. Because of limited resources, he will be able to invest in only one of them. Project A is to purchase a machine that will enable factory automation; the machine is expected to have a useful life of five years and no salvage value. Project B supports a training program that will improve the skills of employees operating the current equipment. Initial cash expenditures for Project A are $103,000 and for Project B are $41,000. The annual expected cash inflows are $34,441 for Project A and $12,522 for Project B. Both investments are expected to provide cash flow benefits for the next five years. Finch Enterprises’ desired rate of return is 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Answer 1

1. The computation of the net present value of each project is as follows:

                                     Project A           Project B

NPV                               $36,523            $9,000

2. Based on the net present value approach, Project A should be adopted, instead of Project B.

What is the net present value?

The net present value is the difference between the costs and the annual cash inflows discounted to their present values.

Data and Calculations:

                                      Project A           Project B

Initial costs                     $103,000          $41,000

Annual cash inflows         $34,441          $12,522

Project live                       5 years            5 years

Rate of return                    8%                    8%

Annuity factor                   3.993             3.993

PV of cash inflows       $139,523          $50,000

NPV                               $36,523            $9,000

Question Completion:

1. Compute the net present value of each project.

2. Which project should be adopted based on the net present value approach?

Thus, based on the net present value approach, Project A should be adopted.

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