Dixie Dynamite Company is evaluating two methods of blowing up old buildings for
ID: 2614426 • Letter: D
Question
Dixie Dynamite Company is evaluating two methods of blowing up old buildings for commercial purposes over the next five years. Method one (implosion) is relatively low in risk for this business and will carry a 12 percent discount rate. Method two (explosion) is less expensive to perform but more dangerous and will call for a higher discount rate of 16 percent. Either method will require an initial capital outlay of $75,000. The inflows from projected business over the next five years are shown next. Which method should be selected using net present value analysis?
Year Method 1 $18,000 24,000 34,000 26,000 14,000 Method2 $20,000 25,000 35,000 28,000 15,000 4Explanation / Answer
METHOD 1: Year Cash flows PVIF at 12% PV at 12% 0 -75000 1.00000 -75000 1 18000 0.89286 16071 2 24000 0.79719 19133 3 34000 0.71178 24201 4 26000 0.63552 16523 5 14000 0.56743 7944 NPV = 8872 METHOD 2: Year Cash flows PVIF at 16% PV at 16% 0 -75000 1.00000 -75000 1 20000 0.86207 17241 2 25000 0.74316 18579 3 35000 0.64066 22423 4 28000 0.55229 15464 5 15000 0.47611 7142 NPV = 5849 As the NPV of Method 1 is higher it is to be selected.