Problem 25-5A Evaluate Alternative Capital Investment Decisions The committee ha

Question

Problem 25-5A
Evaluate Alternative Capital Investment Decisions

The committee has selected a rate of 12% for purposes of net present value analysis. It also estimates that the residual value at the end of each project's useful life is $0, but at the end of the fourth year, the office expansion's residual value would be $200,000.

Required:

1. For each project, compute the net present value. Use the present value of an annuity of $1 table present above. Ignore the unequal lives of the projects. If required, round to the nearest dollar.

2. For each project, compute the net present value, assuming that the office expansion is adjusted to a four-year life for purposes of analysis. Use the present value of $1 table present above.

3. Prepare a report to the investment committee, providing your advice on the relative merits of the two projects.

Present Value of $1 at Compound Interest Year 6% 10% 12% 15% 20% 1 0.943 0.909 0.893 0.870 0.833 2 0.890 0.826 0.797 0.756 0.694 3 0.840 0.751 0.712 0.658 0.579 4 0.792 0.683 0.636 0.572 0.482 5 0.747 0.621 0.567 0.497 0.402 6 0.705 0.564 0.507 0.432 0.335 7 0.665 0.513 0.452 0.376 0.279 8 0.627 0.467 0.404 0.327 0.233 9 0.592 0.424 0.361 0.284 0.194 10 0.558 0.386 0.322 0.247 0.162

Explanation / Answer

1. For each project, compute the net present value. Use the present value of an annuity of $1 table present above. Ignore the unequal lives of the projects. If required, round to the nearest dollar. Office Expansion Server Upgrade Present value of annual net cash flows: $    657,760.00 $     637,770.00 Less amount to be invested: $    610,000.00 $     610,000.00 Net present value: $     47,760.00 $      27,770.00 2. For each project, compute the net present value, assuming that the office expansion is adjusted to a four-year life for purposes of analysis. Use the present value of $1 table present above. Office Expansion Server Upgrade Present value of net cash flow total: $    613,120.00 $     637,770.00 Less amount to be invested: $    610,000.00 $     610,000.00 Net present value: $       3,120.00 $      27,770.00 3. Prepare a report to the investment committee, providing your advice on the relative merits of the two projects. As per unequal lives Adjusted annual effective present value $        11,617.61 $            9,143.89 Hence the effective annual present value is higher in office expansion , I advice to accept office expansion

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