Net Present Value-Unequal Lives Al a Mode, Inc., is considering one of two inves
ID: 2457341 • Letter: N
Question
Net Present Value-Unequal Lives
Al a Mode, Inc., is considering one of two investment options. Option 1 is a $62,000 investment in new blending equipment that is expected to produce equal annual cash flows of $20,000 for each of seven years. Option 2 is a $70,000 investment in a new computer system that is expected to produce equal annual cash flows of $26,000 for each of five years. The residual value of the blending equipment at the end of the fifth year is estimated to be $13,000. The computer system has no expected residual value at the end of the fifth year.
Assume there is sufficient capital to fund only one of the projects. Determine which project should be selected, comparing the (a) net present values and (b) present value indices of the two projects, assuming a minimum rate of return of 15%. Use the present value tables appearing above.
a. Determine the net present values of the two projects.
b. Determine the present value indices of the two projects. If required, round the present value index to two decimal places.
Which project should be selected? (If both present value indices are the same, either project will grade as correct.)
Present Value of $1 at Compound Interest Year 6% 10% 12% 15% 20% 1 0.943 0.909 0.893 0.870 0.833 2 0.890 0.826 0.797 0.756 0.694 3 0.840 0.751 0.712 0.658 0.579 4 0.792 0.683 0.636 0.572 0.482 5 0.747 0.621 0.567 0.497 0.402 6 0.705 0.564 0.507 0.432 0.335 7 0.665 0.513 0.452 0.376 0.279 8 0.627 0.467 0.404 0.327 0.233 9 0.592 0.424 0.361 0.284 0.194 10 0.558 0.386 0.322 0.247 0.162Explanation / Answer
a)
b)
By considering the NPV, the computer system should be selected to purchase because it's NPV of $17,157.20 is more than the belnding equipment's NPV of $11,507.60 and by considering the present value index, both projects are good beacuse both projects' present value index are more than 1.0 which indicate positive NPV. Therefore, the final result is "Computer system" should be selected.
Year Cash in flows ($) (a) Present value factor at 15% (1/1.15) (b) Present value of cash outflows ($) (c = a*b) 1 20,000 0.8696 17392 2 20,000 0.7561 15122 3 20,000 0.6575 13150 4 20,000 0.5718 11436 5 20,000 0.4972 9944 5 13,000 0.4972 6463.6 Total present value of cash flows) 73507.6