Question

Dwight Donovan, the president of Rundle Enterprises, is considering two investment opportunities. Because of limited resources, he will be able to invest in only one of them. Project A is to purchase a machine that will enable factory automation; the machine is expected to have a useful life of five years and no salvage value. Project B supports a training program that will improve the skills of employees operating the current equipment. Initial cash expenditures for Project A are $108,000 and for Project B are $33,000. The annual expected cash inflows are $36,113 for Project A and $9,612 for Project B. Both investments are expected to provide cash flow benefits for the next five years. Rundle Enterprises’ desired rate of return is 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Answer 1

Based on the cashflows of Projects A and B, and the rate of return, the project that Rundle Enterprises should be pick is Project A.

Why should Rundle Enterprises pick Project A?

The project that should be picked is the project with the higher net present value.

The net present value of Project A can be found as:

= Present value of cash flows - Initial cash expenditure

= (36,113 x present value interest factor for an annuity, 8%, 5 years) - 108,000

= 36,113 x 3.99271 - 108,000

= $36,188.74

The net present value of B is therefore:

= 9,612 x 3.99271 - 33,000

= $5,377.93

Project A has the higher present value and should be selected.

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