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.
Thanx guys keep up the good work.You have always been a way out
Hi there,
I tried to replicate the NPV and found a result of 63.052 for the first one and 48.931 for the second one.
I’m pretty worried that I have calculated the NPV in the wrong way for a long time.
Could you please tell me which formula did you use?
Thanks a lot,
Densetsu
It may be a rounding difference. Did you use a software or calculator to find NPV of two projects?
how if it said that you can borrow fund from the bank at 3% and there are estimated cash inflow and cash outflows.
I also had the same result as Densetsu.
I used excel to calculate, just normal simple formulas.
Sir,
I have list some question related to exercise 16 requested too kindly ans me.
1) Depreciation is not calculated as we can caculate through straight line method ? Why? when we need to calculate depreciation?
2) Working capital will always release in every question or it also depend on question to tell us to release?
3)Solvage value in project B is not calculated why?
@Asim
(1). Because no tax rate is given i.e., question ignores the income tax.
Please read from the following pages:
https://www.accountingformanagement.org/exercise-17-cbt/
https://www.accountingformanagement.org/impact-of-income-tax-on-capital-budgeting-decisions/
(2). The release of working capital is mostly mentioned in the question but if no information is given you should assume it.
(3). No salvage value is given for project B.
thanks so much wished to have many questions through my email.God bless u for a good work for our assistance as students