Hint(s) Check My Work Net Present Value—Unequal Lives Gold Creek Mining Company

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Net Present Value—Unequal Lives

Gold Creek Mining Company has two competing proposals: a processing mill and an electric shovel. Both pieces of equipment have an initial investment of $591,602. 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 $230,000.

Determine which equipment should be favored, comparing the net present values of the two proposals and assuming a minimum rate of return of 10%. Use the present value table appearing above.

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Net Present Value—Unequal Lives

Gold Creek Mining Company has two competing proposals: a processing mill and an electric shovel. Both pieces of equipment have an initial investment of $591,602. The net cash flows estimated for the two proposals are as follows:

Net Cash Flow Year      Processing Mill      Electric Shovel 1 $180,000 $225,000 2 160,000 209,000 3 160,000 193,000 4 128,000 198,000 5 97,000 6 81,000 7 70,000 8 70,000

The estimated residual value of the processing mill at the end of Year 4 is $230,000.

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

Determine which equipment should be favored, comparing the net present values of the two proposals and assuming a minimum rate of return of 10%. Use the present value table appearing above.

Processing Mill Electric Shovel Present value of net cash flow total $ $ Less amount to be invested $ $ Net present value $ $

Explanation / Answer

            6,57,336

Gold Creek Mining Company has to favor the Electric Shovel, since the NPV is higher.

The residual value of Processing mill is of no significance at the end of 4th year, since the life of the asset is 8 years.

Processing Mill Electric Shovel Year Cash Flow Present Value rate Present Value Cash Flow Present Value rate Present Value 1    1,80,000                     0.909             1,63,620    2,25,000                     0.909             2,04,525 2    1,60,000                     0.826             1,32,160    2,09,000                     0.826             1,72,634 3    1,60,000                     0.751             1,20,160    1,93,000                     0.751             1,44,943 4        18,000                     0.683                 12,294    1,98,000                     0.683             1,35,234 5        97,000                     0.621                 60,237                          -   6        81,000                     0.564                 45,684 7        70,000                     0.513                 35,910 8        70,000                     0.467                 32,690 PV of Cash Inflow             6,02,755

            6,57,336

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