Answer:
The firm should invest in project X, which yields a net return of $30,000
Explanation:
To determine the project for which the company should invest in, we will calculate the net return (profit) from each investment, and choose the project with the greater profit.
Project Z:
initial investment = $120,000
cash inflow per year = $35,000
cash inflow for the next four years = 35,000 × 4 = $140,000
Net return on investment = 140,000 - 120,000 = 20,000.
Next, you will notice that for the project X, a period of 5 years was given, while for project Z, a 4 year period was given. In order to effectively compare both projects, we will use the same time period, hence, calculating the net return on project X after 4 years:
Project X:
initial investment = $70,000
cash inflow per year = $25,000
cash inflow for the next 4 years = 25,000 × 4 = 100,000
Net return on investment = 100,000 - 70,000 = $30,000
since the net return on investment for project X is greater than that for project Z by $10,000, the firm should invest in project Z.
