The investment committee of Shield Insurance Co. is evaluating two projects, off

Question

The investment committee of Shield Insurance Co. is evaluating two projects, office expansion and upgrade to computer servers. The projects have different useful lives, but each requires an investment of $610,000. The estimated net cash flows from each project are as follows:

NET CASH FLOWS
Yr 1 $160,000 for office expansion $210000 servers

Yr 2 $160,000 for office expansion $210000 servers

Yr 3 $160,000 for office expansion $210000 servers

Yr 4 $160,000 for office expansion $210000 servers

Yr 5 $160,000 for office expansion

Yr 6 $160,000 for office expansion


The committee has selected a rate of 12% for purposes of net present value analysis. It also estimates that the residual value at the end of each project's useful life is $0, but at the end of the fourth year, the office expansion's residual value would be $200,000.

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 0.162

Present Value of an Annuity of $1 at Compound Interest

Year 6% 10% 12% 15% 20%

1 0.943 0.909 0.893 0.870 0.833

2 1.833 1.736 1.690 1.626 1.528

3 2.673 2.487 2.402 2.283 2.106

4 3.465 3.170 3.037 2.855 2.589

5 4.212 3.791 3.605 3.353 2.991

6 4.917 4.355 4.111 3.785 3.326

7 5.582 4.868 4.564 4.160 3.605

8 6.210 5.335 4.968 4.487 3.837

9 6.802 5.759 5.328 4.772 4.031

10 7.360 6.145 5.650 5.019 4.192

Required:

1. For each project, compute the net present value. Use the present value of an annuity of $1 table present above. Ignore the unequal lives of the projects. If required, round to the nearest dollar.

Office Expansion Server Upgrade

Present value of annual net cash flows: $ $

Less amount to be invested: $ $

Net present value: $ $

2. For each project, compute the net present value, assuming that the office expansion is adjusted to a four-year life for purposes of analysis. Use the present value of $1 table present above.

Office Expansion Server Upgrade

Present value of net cash flow total: $ $

Less amount to be invested: $ $

Net present value: $ $

Explanation / Answer

A)

Upgrade

Office Expansion

Server Upgrade

Present value of annual net cash flows:

8000000

840000

Less amount to be invested:

81120

133560

Net present value

7918880

706440

B)

Office Expansion

Server Upgrade

Present value of net cash flow total:

657980

637980

Less amount to be invested:

81120

133560

Net present value:

575860

504420

A)

Upgrade

Office Expansion

Server Upgrade

Present value of annual net cash flows:

8000000

840000

Less amount to be invested:

81120

133560

Net present value

7918880

706440

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