Net Present Value-Unequal Lives Al a Mode, Inc., is considering one of two inves

Question

Net Present Value-Unequal Lives Al a Mode, Inc., is considering one of two investment options. Option 1 is a $40,000 investment in new blending equipment that is expected to produce equal annual cash flows of $13,000 for each of seven years. Option 2 is a $46,000 investment in a new computer system that is expected to produce equal annual cash flows of $17,000 for each of five years. The residual value of the blending equipment at the end of the fifth year is estimated to be $9,000. The computer system has no expected residual value at the end of the fifth year.

Present Value of $1 at Compound Interest 12% 15% 2090 0.943 0.909 0.893 0.870 0.833 0.890 0.826 0.7970.756 0.694 0.840 0.751 0.712 0.658 0.579 0.792 0.683 0.636 0.572 0.482 0.747 0.621 0.567 0.497 0.402 0.705 0.564 0.507 0.432 0.335 0.665 0.513 0.452 0.376 0.279 0.627 0.467 0.404 0.327 0.233 0.592 0.424 0.361 0.284 0.194 0.558 0.386 0.322 0.247 0.162 Present Value of an Annuity of $1 at Compound Interest 2090 0.943 0.909 0.893 0.870 0.833 1.833 1.736 1.690 1.626 1.528 2.673 2.487 2.402 2.283 2.106 3.465 3.170 3.037 2.855 2.589 4.212 3.791 3.605 3.352 2.991 3.784 3.326 5.582 4.868 .564 4.160 3.605 6.210 5.335 4.968 4.487 3.837 6.802 5.759 5.328 4.772 4.031 7.360 6.145 5.650 5.019 4.192 Year 6% 10% 2 4 6 10 Year 6% 10% 12% 15% 2 4 6 4.9174.355 4.111 10 Assume there is sufficient capital to fund only one of the projects. Determine which project should be selected, comparing the (a) net present values and (b) present value indices of the two projects, assuming a minimum rate of return of 15% Use the present value tables appearing above a. Determine the net present values of the two projects Blending Equipment Computer System Total present value of cash flows Less amount to be invested Net present value

Explanation / Answer

a. Based on the information provided for in the problem, the present value of the cash flows is calculated using a minimum rate of return of 15% Blending Computer Equipment System Present Value of Cash Flows $ 43,578.02 $ 56,986.64 Less : Amount to be invested $ 40,000.00 $ 46,000.00 Net Present Value of Investments $ 3,578.02 $ 10,986.64 b. Present Value Index is the ratio of the Net Present Value to the investment being made Present Value Index for Blending Equipment                0.09 Present Value Index for Computer System                0.24 Based on the workings above, and the Present Value Index calculated, it can be inferred that the Computer System project should be selected, since it has both a higher Net Present Value as well as a higher Present Value Index.

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