Net Present Value-Unequal Lives Al a Mode, Inc., is considering one of two inves

Question

Net Present Value-Unequal Lives

Al a Mode, Inc., is considering one of two investment options. Option 1 is a $31,000 investment in new blending equipment that is expected to produce equal annual cash flows of $11,000 for each of seven years. Option 2 is a $36,000 investment in a new computer system that is expected to produce equal annual cash flows of $14,000 for each of five years. The residual value of the blending equipment at the end of the fifth year is estimated to be $7,000. The computer system has no expected residual value at the end of the fifth year.

Assume there is sufficient capital to fund only one of the projects. Determine which project should be selected, comparing the (a) net present values and (b) present value indices of the two projects, assuming a minimum rate of return of 15%. Use the present value tables appearing above.

a. Determine the net present values of the two projects.

b. Determine the present value indices of the two projects. If required, round the present value index to two decimal places.

Which project should be selected? (If both present value indices are the same, either project will grade as correct.)
SelectBlending EquipmentComputer SystemItem 9

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

Question a. Option 1 pv factor Present Year Cashflows at 15% Value 1 11000 0.87 9570 2 11000 0.756 8316 3 11000 0.658 7238 4 11000 0.572 6292 5 11000 0.497 5467 6 11000 0.432 4752 7 11000 0.376 4136 Total 45771 Option 2 pv factor Present Year Cashflows at 15% Value 1 14000 0.87 12180 2 14000 0.756 10584 3 14000 0.658 9212 4 14000 0.572 8008 5 14000 0.497 6958 total 46942 Question a. Blending Computer Equipment System Total Present Value of cashflows 45771 46942 Less: Amount to be invested 31000 36000 Net Present Value 14771 10942 Question b. Present Value Index Blending Equipment 1.48 Computer System 1.30 Blending Machine should be selected.

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