Dolly Company is contemplating three different equipment investments. The releva
ID: 2504151 • Letter: D
Question
Dolly Company is contemplating three different equipment investments. The relevant data follows:
Proposal D Proposal O Proposal G
Cost $200,000 $320,000 $830,000
Annual savings of cash operating costs $40,000 $100,000 $150,000
Terminal salvage value 0 0 0
Estimated useful life in years 1 0 1 0 1 0
Minimum desired rate of return 12% 12% 12%
Method of depreciation Straight-line Straight-line Straight-line
The present value factor of an ordinary annuity for 10 periods at 12% is 5.6502.
The present value factor of one for 10 periods at 12% is 0.322.
Required:
A) Compute the net present value of each investment. Ignore income taxes.
B) If only one investment can be acquired, which investment should be chosen
Explanation / Answer
Hi,
Please find the detailed answer as follows:
NPV is the difference between the present value of all cash outlows and present value of all cash inflows/benefits provided by the investment.
Part A: NPV Calculations:
NPV (Proposal D)
Initial Investment = -200000
Annual Cash Inflows (Savings) = 40000
NPV = -200000 + 40000*PVIFA*(12%,10) = -200000 + 40000*5.6502 = 26008
-------------------------------------------------
NPV (Proposal O)
Initial Investment = -320000
Annual Cash Inflows (Savings) = 100000
NPV = -320000 + 100000*PVIFA*(12%,10) = -320000 + 100000*5.6502 = 245020
-------------------------------------------------
NPV (Proposal G)
Initial Investment = -830000
Annual Cash Inflows (Savings) = 150000
NPV = -830000 + 150000*PVIFA*(12%,10) = -830000 + 150000*5.6502 = 17530
Part B: Decision:
Proposal O should be chosen since it offers the highest NPV.
Notes:
We have already been provided with annual cash operating savings, so we don't need to perform depreciation calculations to calculate annual operating cash inflow.
Thanks.
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