Joe’s Technology must choose between two repeatable methods of producing a new p
ID: 2821778 • Letter: J
Question
Joe’s Technology must choose between two repeatable methods of producing a new product. The initial costs and year-end cash benefits are as follows:
Year 0 1 2 3 4 5
Method M -$1,500,000 600,000 750,000 550,000 200,000
Method N -$2,500,000 1,200,000 950,000 700,000 400,000 300,000
Assume all cash flows occur at year-end and the company’s required return is 6.57 percent.
Please compute the net present value ______________ and the equivalent annuity ________________ for Method M
Please compute the net present value ______________ and the equivalent annuity ________________ for Method N
Which production method should be used? _______________
Explanation / Answer
Computation of net present value and the equivalent annuity
- Method M
Net Present Value = PV of Inflows - PV of Outflows
= (563010.23+660376.08+454420.37+155056.56) - 1500000
= 1832863.23-1500000
=332,863.23
Equivalent Annuity Cash flow = (r(NPV)) / (1-(1+r)^-n)
where
r - rate per period
n - no. of periods
NPV - Net Present Value
Equivalent Annuity Cash flow = (.0657(332863.23)) / (1-(1.0657)^-4)
= 21869.114211/.22471722172
= 97,318.37
- Method N
Net Present Value = PV of Inflows - PV of Outflows
= (1126020.46+836476.36+578353.20+310113.11+218246.07)-2500000
= 3069209.20-2500000
= 569,209.20
Equivalent Annuity Cash flow = (.0657(569209.20)) / (1-(1.0657)^-5)
= 37397.04444/0.27251311036
= 137,230.26
Decision: Both NPV and equivalent annuity is higher for Method N, so it should be accepted.
Year Cashflow PVF@6.57% Cashflow*PVF 0 (1,500,000) 1 (1,500,000.00) 1 600,000 0.9384 563010.23 2 750,000 0.8805 660376.08 3 550,000 0.8262 454420.37 4 200,000 0.7753 155056.56Related Questions
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