A Company is considering two alternative methods of producing a new product. The
ID: 2708607 • Letter: A
Question
A Company is considering two alternative methods of producing a new product. The relevant data concerning the alternatives are presented below. Alternative 1: Initial Investment $50,000, Annual Receipts $36,000, Annual disbursements $16,000, Annual depreciation $12,000, Expected Life 5 years, Salvage Value $0 Alternative 2: Initial Investment $110,000, Annual Receipts $50,000, Annual disbursements $10,000, Annual depreciation $16,000, Expected Life 7 years, Salvage Value $0 At the end of the useful life of whatever equipment is chosen the product will be discontinued. The company's tax rate is 50 percent, and its cost of capital is 11 percent.
What is the NET PRESENT VALUE? Which one should the company choose?
Explanation / Answer
Initial Investment $50,000
Annual Receipts $36,000
Annual disbursements $16,000
Annual depreciation $12,000,
Annual Cash Flow = (36,000-16,000-12000)(1-0.5) + 12,000 = 16,000
Expected Life 5 years
NPV = -50,000 + 16000/1.11 + 16000/1.11^2 .......+16000/1.11^5 = $9134.35
Alternative 2:
Initial Investment $110,000,
Annual Receipts $50,000
Annual disbursements $10,000
Annual depreciation $16,000
Annual Cash Flow = (50,000-10,000-16000)*(1-0.5) + 16,000 = 28,000
Expected Life 7 years,
NPV = -110,000 + 28000/1.11 + 28000/1.11^2 +.....28000/1.11^7
NPV = $21,941.5
Choose Alternative 2
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