Alternative Capital Investments The investment committee of Shield Insurance Co.

Question

Alternative Capital Investments

The investment committee of Shield Insurance Co. is evaluating two projects, office expansion and upgrade to computer servers. The projects have different useful lives, but each requires an investment of $560,000. The estimated net cash flows from each project are as follows:

Office Expansion

Server Upgrade

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 $184,000.

Required:

If required, use the minus sign to indicate a negative net present value.

1. For each project, compute the net present value. Use the present value of an annuity of $1 table 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 above.

Net Cash Flow Year     

Office Expansion

    

Server Upgrade

1 $147,000 $194,000 2 147,000 194,000 3 147,000 194,000 4 147,000 194,000 5 147,000 6 147,000

Explanation / Answer

1)

2)

Cash flow from office expansion

= $147000 x PVIFA(12%,4) + $184000 x PVIF(12%,4)

= $147000 x 3.04 + $184000 x 0.636

=$563904

Project Office expnasion Server Upgrade Annual cash inflow $ 1,47,000.00 $ 1,94,000.00 PVIFA(12%, 6) $ 4.11 PVIFA(12%,4) $ 3.04 PV of cash inflow $ 6,04,317.00 $     5,89,178.00 Less: amount to be invested $ -5,60,000.00 $ -5,60,000.00 NPV $ 44,317.00 $ 29,178.00

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