Net Present Value—Unequal Lives Bunker Hill Mining Company has two competing pro
ID: 2580658 • Letter: N
Question
Net Present Value—Unequal Lives
Bunker Hill Mining Company has two competing proposals: a processing mill and an electric shovel. Both pieces of equipment have an initial investment of $750,000. The net cash flows estimated for the two proposals are as follows:
The estimated residual value of the processing mill at the end of Year 4 is $280,000.
Determine which equipment should be favored, comparing the net present values of the two proposals and assuming a minimum rate of return of 15%. Use the present value table appearing above. If required, round to the nearest dollar.
Net Cash Flow Year Processing Mill Electric Shovel 1 $310,000 $330,000 2 260,000 325,000 3 260,000 325,000 4 260,000 320,000 5 180,000 6 130,000 7 120,000 8 120,000Explanation / Answer
1. Calculation of Present Value of net Cash flows
Particulars
Time(n)
Present Value Factor (1/ (1.15)n), i=15%
(B)
Processing Mill (A x B)
Electric Shovel
Cash Flows:
Year 1
1
0.870
310,000 x 0.870 = 269,700
330,000 x 0.870 = 287,100
Year 2
2
0.756
196,560
245,700
Year 3
3
0.658
171,080
213,850
Year 4
4
0.572
148,720
183,040
Year 5
5
0.497
89,460
Year 6
6
0.432
56,160
Year 7
7
0.376
45,120
Year 8
8
0.327
39,240
Net Present Value
1,016,040
929,690
Cumulative Present Value of Time
For 8 years = 4.488
For 4 years = 2.856
Processing Mill
Electric Shovel
Present Value of net cash flows
1,016,040
929,690
Less: Amount to be invested
750,000
750,000
Net Present Value
266,040
179,690
However, in the given case both the investments have unequal lives and therefore,we have to calculate the Effective Net Present Value for decision making
Effective Net Present Value = Net Present Value / Cumulative Present value of time
Processing Mill = 266,040 / 4.488 = $59,278
Electric Shovel = 179,690 / 2.856 = $62,916.67
Since the effective net present value of electric shovel is more than the processing mill, the same should be purchased by the company.
Particulars
Time(n)
Present Value Factor (1/ (1.15)n), i=15%
(B)
Processing Mill (A x B)
Electric Shovel
Cash Flows:
Year 1
1
0.870
310,000 x 0.870 = 269,700
330,000 x 0.870 = 287,100
Year 2
2
0.756
196,560
245,700
Year 3
3
0.658
171,080
213,850
Year 4
4
0.572
148,720
183,040
Year 5
5
0.497
89,460
Year 6
6
0.432
56,160
Year 7
7
0.376
45,120
Year 8
8
0.327
39,240
Net Present Value
1,016,040
929,690
Cumulative Present Value of Time
For 8 years = 4.488
For 4 years = 2.856
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