Redmond Company is considering investing in one of the following two projects: (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required:1) Which project is more desirable strictly in terms of cash inflows? Why? 2) Compute the present value of each project's cash inflows assuming the company's required rate of return is 12%. 3) What is the maximum amount Redmond should be willing to pay for each project? 4) Suppose each project costs $7,000. Which project(s) should be accepted? Note that only one project can be accepted.

Question

What will be an ideal response?

Answer 1

Answers will vary

1) Project B is more desirable because the majority of the cash flows occur earlier. The timing of the cash flows is important because of the concept of the time value of money which recognizes the fact that the present value of a dollar received in the future is worth less than a dollar.

2) Present values:

 

3) Maximum that should be paid: Project A = $6,948.15; Project B = $7,224.90

4) Redmond should accept Project B because its NPV is positive (after subtracting the initial outflow of $7,000), while Project A's is negative (after subtracting the initial outflow of $7,000).