Dolly Company is contemplating three different equipment investments. The releva

Question

Dolly Company is contemplating three different equipment investments. The relevant data follows:

Proposal D Proposal O Proposal G

Cost $200,000 $320,000 $830,000

Annual savings of cash operating costs $40,000 $100,000 $150,000

Terminal salvage value 0 0 0

Estimated useful life in years 1 0 1 0 1 0

Minimum desired rate of return 12% 12% 12%

Method of depreciation Straight-line Straight-line Straight-line

The present value factor of an ordinary annuity for 10 periods at 12% is 5.6502.

The present value factor of one for 10 periods at 12% is 0.322.

Required:

A) Compute the net present value of each investment. Ignore income taxes.

B) If only one investment can be acquired, which investment should be chosen

Explanation / Answer

Hi,

Please find the detailed answer as follows:

NPV is the difference between the present value of all cash outlows and present value of all cash inflows/benefits provided by the investment.

Part A: NPV Calculations:

NPV (Proposal D)

Initial Investment = -200000

Annual Cash Inflows (Savings) = 40000

NPV = -200000 + 40000*PVIFA*(12%,10) = -200000 + 40000*5.6502 = 26008

-------------------------------------------------

NPV (Proposal O)

Initial Investment = -320000

Annual Cash Inflows (Savings) = 100000

NPV = -320000 + 100000*PVIFA*(12%,10) = -320000 + 100000*5.6502 = 245020

-------------------------------------------------

NPV (Proposal G)

Initial Investment = -830000

Annual Cash Inflows (Savings) = 150000

NPV = -830000 + 150000*PVIFA*(12%,10) = -830000 + 150000*5.6502 = 17530

Part B: Decision:

Proposal O should be chosen since it offers the highest NPV.

Notes:

We have already been provided with annual cash operating savings, so we don't need to perform depreciation calculations to calculate annual operating cash inflow.

Thanks.

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