Roy Company Is Trying to Decide Whether to Invest in One

question 97

Essay

Roy Company is trying to decide whether to invest in one of two projects: X or Z.Associated data for each investment project follow:

$\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\text { Project }$
$\begin{array}{lcc}&\mathrm{X}&\mathrm{Z}\\\text { Cost of equipment } & \$ 90,000 & \$ 140,000 \\\text { Useful life } & 6 \text { years } & 9 \text { years } \\\text { Annual net cash inflow } & \$ 25,000 & \$ 30,000 \\\text { Salvage value } & \$ 8,000 & \$ 12,000\end{array}$

The equipment for each project is in Class 22 with a 30% maximum CCA rate. The income tax rate is 30%. Roy's after-tax cost of capital is 12%.

Required:

a) Calculate the net present value of each project, and indicate which appears preferable in terms of net present value.
b) Calculate the profitability index for each project, and indicate which project would be preferable using this investment criterion.

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Definitions:

Productive Capacity

The maximum output a firm or economy can produce with the current level of resources and technology, indicating potential growth limits.

Efficiently

The ability to achieve a goal or fulfill a function with the least waste of time and effort; maximizing productivity with minimum wasted effort or expense.

Economic Model

A simplified representation of economic processes, typically using mathematical formulas, to understand and predict economic behaviors.

Scientific Method

A systematic process of questioning, data collection, analysis, and hypothesis testing used to explore observations and answer questions.