Net Present Value Analysis of Two Alternatives
Over the Rainbow Company has $300,000 to invest. The company is trying to decide between two alternative uses of the funds. The alternatives are as follows:
|
|
A
|
B
|
|
Cost of equipment required
|
$300,000
|
$0
|
|
Working capital investment required
|
$0
|
$300,000
|
|
Annual cash inflows
|
$ 80,000
|
$ 60,000
|
|
Salvage value of equipment in seven years.
|
$ 20,000
|
$0
|
|
Life of the project
|
7 years
|
7 years
|
The working capital needed for Project B will be released for investment elsewhere at the end of seven years. Over the Rainbow Company uses a 20% discount rate.
Required:
Ignore income taxes. Which investment alternative (if either) would you recommend that the company accept? Show all computations using the net present value format. Prepare separate computations for each project.