Dixie Dynamite Company is evaluating two methods of blowing up old buildings for
ID: 2619450 • 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 17 percent. Either method will require an initial capital outlay of $110,000. The inflows from the projected business over the next five years are shown next.
Years Method 1 Method 2
1 $ 33,800 $ 18,800
2 33,200 29,500
3 42,100 38,100
4 34,800 38,600
5 19,200 71,200
Use Appendix B for an approximate answer but calculate your final answers using the formula and financial calculator methods.
a. Calculate net present value for Method 1 and Method 2.(Do not round intermediate calculations and round your answers to 2 decimal places.)
b. Which method should be selected using net present value analysis? Method 1 Method 2 Neither of these
Explanation / Answer
Requirement (a) - Net Present Value
Net Present Value [NPV] = Present Value of cash Inflows – Initial Investment
METHOD - 1
Year
Annual Cash Inflows
Present Value factor at 12%
Present Value of Annual cash Inflows
1
33,800
0.892857143
$30,178.57
2
33,200
0.797193878
$26,466.84
3
42,100
0.711780248
$29,965.95
4
34,800
0.635518078
$22,116.03
5
19,200
0.567426856
$10,894.60
$119,621.99
Net Present Value [NPV] = $119,621.99 - 110,000 = $ 9,621.99
METHOD - 2
Year
Annual Cash Inflows
Present Value factor at 17%
Present Value of Annual cash Inflows
1
18,800
0.854700855
$16,068.38
2
29,500
0.730513551
$21,550.15
3
38,100
0.624370556
$23,788.52
4
38,600
0.533650048
$20,598.89
5
71,200
0.456111152
$32,475.11
$114,481.05
Net Present Value [NPV] = $114,481.05 - 110,000 = $ 4,481.05
Requirement (b) – Selection of Method
“Method 1” Should be selected, Since the Net Present Value is higher in Method 1 as compared to Method 2
Year
Annual Cash Inflows
Present Value factor at 12%
Present Value of Annual cash Inflows
1
33,800
0.892857143
$30,178.57
2
33,200
0.797193878
$26,466.84
3
42,100
0.711780248
$29,965.95
4
34,800
0.635518078
$22,116.03
5
19,200
0.567426856
$10,894.60
$119,621.99