Alternative Capital Investments The investment committee of Shield Insurance Co.

Question

Alternative Capital Investments

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 $849,000. The estimated net cash flows from each project are as follows:

Office Expansion

Server Upgrade

The committee has selected a rate of 10% 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 $268,000.

Required:

If required, use the minus sign to indicate a negative net present value.

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

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 above.

Net Cash Flow Year     

Office Expansion

    

Server Upgrade

1 $214,000 $282,000 2 214,000 282,000 3 214,000 282,000 4 214,000 282,000 5 214,000 6 214,000

Explanation / Answer

1.

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.

year cash flow $-Office Expansion discount rate Present Value $- office expansion Cash flow $ - Server Upgrade Present Value $- Server Upgrade 1 214,000 0.909 194526 282,000 256338 2 214,000 0.826 176764 282,000 232932 3 214,000 0.751 160714 282,000 211782 4 214,000 0.683 146162 282,000 192606 5 214,000 0.621 132894 - 6 214,000 0.564 120696 - Present Value of cash flow 931756 893658 Initial cost ($849,000) ($849,000) Net Present Value $82756 $44658

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