Exercise-16 (Net present value analysis of two alternatives)

The Sunshine company is considering two projects, project A and project B. Project A requires the purchase of an equipment but no working capital investment whereas project B requires a working capital investment but no equipment. The relevant information for net present value analysis is given below:

The working capital required for project B will be released at the end of project life. Sunshine company uses an 18% discount rate.

Required: Are the two projects comparable using net present value (NPV)? If yes, Select the best investment using net present value (NPV) method. (Ignore income tax).

Solution:

Yes, the two projects are comparable because both the projects require equal amount of initial investment.

NPV of project A:

*Value from “present value of an annuity of $1 in arrears table“.
**Value from “present value of $1 table”.

NPV of project B:

*Value from “present value of an annuity of $1 in arrears table“.
**Value from “present value of $1 table“.

Conclusion:

According to NPV method, project A looks more desirable because its net present value is more than project B.