Hearne Company has a number of potential capital investments. Because these proj

Question

Hearne Company has a number of potential capital investments. Because these projects vary in nature, initial investment, and time horizon, management is finding it difficult to compare them. Assume straight line depreciation method is used.

Project 1: Retooling Manufacturing Facility This project would require an initial investment of $5,400,000. It would generate $964,000 in additional net cash flow each year. The new machinery has a useful life of eight years and a salvage value of $1,132,000. Project

2: Purchase Patent for New Product The patent would cost $3,785,000, which would be fully amortized over five years. Production of this product would generate $681,300 additional annual net income for Hearne.

Project 3: Purchase a New Fleet of Delivery Trucks Hearne could purchase 25 new delivery trucks at a cost of $170,000 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $6,100. Purchasing the fleet would allow Hearne to expand its customer territory resulting in $765,000 of additional net income per year.

Using a discount rate of 10 percent, calculate the net present value of each project. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) ??

Explanation / Answer

Particulars Year PVF @ 10% Cash Flow Project A Cash Flow Project B Cash Flow Project C PV Project A PV Project B PV Project C Initial Investment 0           1.00       (54,00,000) (37,85,000) (42,50,000)       (54,00,000)       (37,85,000)       (42,50,000) Cash Flows 1           0.91          9,64,000     6,81,300     7,65,000          8,76,364          6,19,364          6,95,455 Cash Flows 2           0.83          9,64,000     6,81,300     7,65,000          7,96,694          5,63,058          6,32,231 Cash Flows 3           0.75          9,64,000     6,81,300     7,65,000          7,24,267          5,11,871          5,74,756 Cash Flows 4           0.68          9,64,000     6,81,300     7,65,000          6,58,425          4,65,337          5,22,505 Cash Flows 5           0.62          9,64,000     6,81,300     7,65,000          5,98,568          4,23,034          4,75,005 Cash Flows 6           0.56          9,64,000              -       7,65,000          5,44,153                   -            4,31,823 Cash Flows 7           0.51          9,64,000              -       7,65,000          4,94,684                   -            3,92,566 Cash Flows 8           0.47          9,64,000              -       7,65,000          4,49,713                   -            3,56,878 Cash Flows 8           0.47        11,32,000              -                -            5,28,086                   -                     -   Cash Flows 9           0.42                   -                -       7,65,000                   -                     -            3,24,435 Cash Flows 10           0.39                   -                -       7,65,000                   -                     -            2,94,941 Cash Flows 10           0.39                   -                -       1,52,500                   -                     -              58,795 Net Present Value          2,70,955       (12,02,337)          5,09,389

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