Question
Professor Upton is evaluating two projects for a client.
Project A Project B
Original Cost $250,000 $235,000
Increase in Revenue/yr $110,000 $125,000
Labor Cost/yr $ 26,000 $ 35,000
Material Cost/yr $ 12,000 $ 24,000
Overhead Depreciation $ 25,000 $ 45,000
a) All cost figures are cash outlays, except the overhead charge which is an accounting entry. Both projects have lifespan of 5 yrs. If the company wants to use an 11% rate of return, which project should Professor Upton recommend?
b) Suppose Project A has a salvage value of $5,000; Project b $20,000. Does your answer in part a change?
Explanation / Answer
1) Select Project A as the NPV is higher than Project B Project A 0 1 2 3 4 5 Cost (250,000.00) Inc in Revenue 110,000.00 110,000.00 110,000.00 110,000.00 110,000.00 Labor Cost (26,000.00) (26,000.00) (26,000.00) (26,000.00) (26,000.00) Mat Cost / yr (12,000.00) (12,000.00) (12,000.00) (12,000.00) (12,000.00) Total Net Cash Flows (250,000.00) 72,000.00 72,000.00 72,000.00 72,000.00 72,000.00 Interest Rae 11% NPV 16,104.59 Project B 0 1 2 3 4 5 Cost (235,000.00) Inc in Revenue 125,000.00 125,000.00 125,000.00 125,000.00 125,000.00 Labor Cost (35,000.00) (35,000.00) (35,000.00) (35,000.00) (35,000.00) Mat Cost / yr (24,000.00) (24,000.00) (24,000.00) (24,000.00) (24,000.00) Total Net Cash Flows (235,000.00) 66,000.00 66,000.00 66,000.00 66,000.00 66,000.00 Interest Rae 11% NPV 8,929.20