Hearne Company has a number of potential capital investments. Because these proj

Question

Hearne Company has a number of potential capital investments. Because these projects vary in nature, initial investment, and time horizon, management is finding it difficult to compare them. Assume straight line depreciation method is used.

Project 1: Retooling Manufacturing Facility This project would require an initial investment of $5,350,000. It would generate $955,000 in additional net cash flow each year. The new machinery has a useful life of eight years and a salvage value of $1,120,000.

Project 2: Purchase Patent for New Product The patent would cost $3,750,000, which would be fully amortized over five years. Production of this product would generate $656,250 additional annual net income for Hearne.

Project 3: Purchase a New Fleet of Delivery Trucks Hearne could purchase 25 new delivery trucks at a cost of $165,000 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $6,000. Purchasing the fleet would allow Hearne to expand its customer territory resulting in $721,900 of additional net income per year.

1. Using a discount rate of 10 percent, calculate the net present value of each project. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.)

2. Determine the profitability index of each project and prioritize the projects for Hearne

Explanation / Answer

Solution 1:

Solution 2:

Compuation of NPV Particulars Period PV Factor Project 1 Amount Present value Cash Outflows: Initial Cost 0 1 $53,50,000 $53,50,000 Present value of cash outflows (A) $53,50,000 Cash Inflows: Annual Cash Inflows 1-8 5.334926 $9,55,000 $50,94,855 Salvage Value 8 0.466507 $11,20,000 $5,22,488 Present Value of cash inflows (B) $56,17,343 NPV (B-A) $2,67,343

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