Dixie Dynamite Company is evaluating two methods of blowing up old buildings for

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 11 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 $110,000. The inflows from projected business over the next five years are shown next.  
  

   
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?

Years Method 1 Method 2 1 $ 34,400 $ 20,200 2 35,400 26,800 3 40,900 40,600 4 34,100 34,400 5 27,400 79,100 Appendix B Present value of $1, PVF PV=FV Percent Period 9 7 4 Percent Period 2 1 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694 0.640 0.592 0.549 0.510 0.444 0.613 0.592 0.572 0.552 0.534 0.515 0.499 0.482 0.410 0.350 0.301 0.260 0.198 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335 0.262 0.207 0.165 0.133 0.088 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233 0.168 0.123 0.091 0.068 0.039 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162 0.107 0.073 0.050 0.035 0.017 0.098 0.083 0.070 0.060 0.051 0.043 0.037 0.031 0.014 0.007 0.003 0.002 0 0.047 0.038 0.030 0.024 0.020 0.016 0.013 0.010 0.004 0.001 0.001 0

Explanation / Answer

NPV = Present value of cash inflows - present value of cash outflows

Method 1:

Present value of cash inflows = (34,400 * 0.901) + (35,400 * 0.812) + (40,900 * 0.731) + ( 34,100 * 0.659) + ( 27,400 * 0.593)

Present value of cash inflows = 30,994.4 + 28,744.8 + 29,897.9 + 22,471.9 + 16,248.2

Present value of cash inflows = 128,357.2

NPV = 128,357.2 - 110,000

NPV = 18,357.2

NPV using formula and financial calculator:

NPV = 110,000 + 34,400 / ( 1 + 0.11)1 + 35,400 / ( 1 + 0.11)2 + 40,900 / ( 1 + 0.11)3 + 34,100 / ( 1 + 0.11)4 + 27,400 / ( 1 + 0.11)5

NPV = 18,351.46

Method 2:

Present value of cash inflows = (20,200 * 0.862) + (26,800 * 0.743) + (40,600 * 0.641) + ( 34,400 * 0.552) + ( 79,100 * 0.476)

Present value of cash inflows = 17,412.4 + 19,912.4 + 26,024.6 + 18,988.8 + 37,651.6

Present value of cash inflows = 119,989.8

NPV = 119,989.8 - 110,000

NPV = 9,989.9

NPV using formula and financial calculator:

NPV = 110,000 + 20,200 / ( 1 + 0.16)1 + 26,800 / ( 1 + 0.16)2 + 40,600 / ( 1 + 0.16)3 + 34,400 / ( 1 + 0.16)4 + 79,100 / ( 1 + 0.16)5

NPV = 10,000.6

2)

It should decide method 1 as it has the higher NPV

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