BEFORE CLASS PREP 5: NET PRESENT VALUE METHOD Background: What is the philosophy
ID: 2466807 • Letter: B
Question
BEFORE CLASS PREP 5: NET PRESENT VALUE METHOD
Background: What is the philosophy of the NPV method?
Action Plan: What are the four basic steps? See CP 4 Solve: White Company is trying to decide whether to remodel an old car wash or remove it entirely and install a new one in its place. Determine the NPV of each alternative. The company uses a 10% discount rate.
New Car Wash Old Car Wash
Annual revenues $ 90,000 $ 70,000
Annual cash operating costs 30,000 22.500
Net annual cash inflows $ 60,000 $ 47,500
Calculating the NPV of each decision separately
Amount of 10% Present Value
Year(s) Amount of Cash Flows 10% Factor Present Value of Cash Flows
Install new car wash
Initial investment Now $ (300,000)
Replacement brushes 6 (50,000)
Salvage of old equipment Now 40,000
Salvage of new equipment 10 7,000
Net annual cash inflows 1-10 60,000
Remodel old car wash:
Initial investment Now $ (175,000)
Replacement brushes 6 (80,000)
Salvage of old equipment 10 -0-
Net annual cash flows 1-10 47,500
Evaluate: Which project should you choose? Why? What does a positive NPV indicate? A negative NPV? A NPV of zero?
Explanation / Answer
Ans) White Company New Car Old Car Annual Revenue $ 90,000.00 $ 70,000.00 Annual Cash Operating Cost $ 30,000.00 $ 22,500.00 Net Annual Cash Inflows $ 60,000.00 $ 47,500.00 Install New Car Wash Year Cash Flow Discounting Factor at 10% Present Value Initial Investment 0 $ (300,000.00) 1 $ (300,000.00) Salvage Value of old equipment 0 $ 40,000.00 1 $ 40,000.00 Repalcement of Brushes 6 $ (50,000.00) 0.56447 $ (28,223.50) Net Annual Cash Inflows 1-10 year $ 60,000.00 6.1446 $ 368,676.00 Salvage Value of new equipment 10 $ 7,000.00 0.38554 $ 2,698.78 Net Present Value $ 83,151.28 Remodel Old Car Wash Year Cash Flow Discounting Factor at 10% Present Value Initial Investment 0 $ (175,000.00) 1 $ (175,000.00) Repalcement of Brushes 6 $ (80,000.00) 0.56447 $ (45,157.60) Net Annual Cash Inflows 1-10 year $ 47,500.00 6.1446 $ 291,868.50 Salvage Value of Old equipment 10 $ - $ - Net Present Value $ 71,710.90 Net Present Value of install new car is greater than the removal old car wash so Project 1 of install a new car should be accepted. A positive NPV indcates that earning generated by project is more than its cost so project should be accepted. A Negative NPV indicates Cash outflow is more than the cash inflow so project should not be accepted. A Zero NPV indicates no value.
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