Answer & Question

Friday, 20 April 2018

Labeau Products, Ltd., of Perth, Australia, has $23,000 to invest. The company is trying to decide between two alternative uses for the funds as follows:

Labeau Products, Ltd., of Perth, Australia, has $23,000 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	$	23,000	$	23,000
Annual cash inflows	$	7,000
Single cash inflow at the end of 6 years			$	43,000
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

Project X:

	Now			Years 1-6
Initial investment	$	(23,000	)
Annual cash inflows				$	7,000
Total cash flows (a)	$	(23,000	)	$	7,000
Discount factor (16%) (b)		1.000			3.685
Present value (a) × (b)	$	(23,000	)	$	25,795
Net present value	$	2,795

Project Y:

	Now			Year 6
Initial investment	$	(23,000	)
Single cash inflow				$	43,000
Total cash flows (a)	$	(23,000	)	$	43,000
Discount factor (16%) (b)		1.000			0.410
Present value (a) × (b)	$	(23,000	)	$	17,630
Net present value	$	(5,370	)

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

here

Oxford Company has limited funds available for investment and must ration the funds among four competing projects. Selected information on the four projects follows:

Project	Investment Required		Net Present Value		Life of the Project (years)	Internal Rate of Return
A	$	860,000	$	407,670	8	22	%
B	$	750,000	$	247,227	13	16	%
C	$	710,000	$	366,716	8	23	%
D	$	910,000	$	225,463	4	21	%

The net present values above have been computed using a 10% discount rate. The company wants your assistance in determining which project to accept first, second, and so forth.

Required:

1. Compute the project profitability index for each project.

2. In order of preference, rank the four projects in terms of net present value, project profitability index and internal rate of return.

The project profitability index is computed as follows:

Project	Net Present Value (a)		Investment Required (b)		Project Profitability Index (a) ÷ (b)
A	$	407,670	$	860,000	0.47
B	$	247,227	$	750,000	0.33
C	$	366,716	$	710,000	0.52
D	$	225,463	$	910,000	0.25