Labeau Products, Ltd., of Perth, Australia, has $25,000 to invest. The company is trying to decide between two alternative uses for the funds as follows:

Labeau Products, Ltd., of Perth, Australia, has $25,000 to invest. The company is trying to decide between two alternative uses for the funds as follows:

	Invest in Project X		Invest in Project Y
Investment required	$	25,000	$	25,000
Annual cash inflows	$	8,000
Single cash inflow at the end of 6 years			$	60,000
Life of the project	6 years		6 years

The company’s discount rate is 16%.

Required:

1. Compute the net present value of Project X.

2. Compute the net present value of Project Y.

3. Which project would you recommend the company accept?

 

Explanation

1.

Project X:

	Now			Years 1-6
Initial investment	$	(25,000	)
Annual cash inflows				$	8,000
Total cash flows (a)	$	(25,000	)	$	8,000
Discount factor (16%) (b)		1.000			3.685
Present value (a) × (b)	$	(25,000	)	$	29,480
Net present value	$	4,480

2.

Project Y:

	Now			Year 6
Initial investment	$	(25,000	)
Single cash inflow				$	60,000
Total cash flows (a)	$	(25,000	)	$	60,000
Discount factor (16%) (b)		1.000			0.410
Present value (a) × (b)	$	(25,000	)	$	24,600
Net present value	$	(400	)

3.

Project X should be selected. Project Y does not provide the required 16% return, as shown by its negative net present value.

Thanks