Vanderheiden Inc. is considering two average-risk alternative ways of producing

Question

Vanderheiden Inc. is considering two average-risk alternative ways of producing its patented polo shirts. Process S has a cost of $8,000 and will produce net cash flows of $5,000 per year for 2 years. Process L will cost $11,500 and will produce cash flows of $4,000 per year for 4 years. The company has a contract that requires it to produce the shirts for 4 years, but the patent will expire after 4 years, so the shirts will not be produced after 4 years. If cash inflows occur at the end of each year, and if Vanderheiden's cost of capital is 10 percent, What is the NPV of the better project?

Explanation / Answer

Process S:
==========
Year 0 Year 1 Year 2 Year 3 Year 4
Cost (8,000) - (8,000) - -
Inflow - 5,000 5,000 5,000 5,000
-------------------------------------...
(8,000) 5,000 (3,000) 5,000 5,000
Discount Factor 1 0.909 0.826 0.751 0.683
-------------------------------------...
Net (8,000) 4,545 (2,478) 3,755 3,415
=====================================...
Total = 1,237/-

Process L:
==========
Year 0 Year 1-4
Cost (11,500) -
Inflow - 4,000
-------------------------------
(11,500) 4,000
Discount Factor 1 3.170*
--------------------------------
Net (11,500) 12,680
===================
Total = 1,180/-
* Annuity Factor = {1-[1/(1+i)^n]}/i => {1-[1/(1+0.1)^4]}/0.1

Process S is more profitable.

Assumptions; There is no Inflation and each cash flow incurred at end of the year.

Related Questions

Navigate

• Browse (All)
• Browse V
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.