The investment committee of Shield Insurance Co. is evaluating two projects, off
ID: 2494586 • Letter: T
Question
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 $1,345,000. The estimated net cash flows from each project are as follows:
Office Expansion
Server Upgrade
The committee has selected a rate of 15% 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 $470,000.
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 YearOffice Expansion
Server Upgrade
1 $376,000 $496,000 2 376,000 496,000 3 376,000 496,000 4 376,000 496,000 5 376,000 6 376,000Explanation / Answer
1)
2)
Working
1)
Office Expansion
Present value of annual net cash flows = annual net cash flows*PVIFA(rate,nper)
Present value of annual net cash flows = 376000*PVIFA(15%,6)
Present value of annual net cash flows = 376000*3.784
Present value of annual net cash flows = 1422784
Server Upgrade
Present value of annual net cash flows = annual net cash flows*PVIFA(rate,nper)
Present value of annual net cash flows = 496000*PVIFA(15%,4)
Present value of annual net cash flows = 496000*2.855
Present value of annual net cash flows = 1416080
2)
Office Expansion
Present value of annual net cash flows = annual net cash flows*PVIFA(rate,nper) + Salvage value*PVIF(rate,nper)
Present value of annual net cash flows = 376000*PVIFA(15%,4) + 470000*PVIF(15%,4)
Present value of annual net cash flows = 376000*2.855 + 470000*0.572
Present value of annual net cash flows = 1342320
Server Upgrade
Present value of annual net cash flows = annual net cash flows*PVIFA(rate,nper)
Present value of annual net cash flows = 496000*PVIFA(15%,4)
Present value of annual net cash flows = 496000*2.855
Present value of annual net cash flows = 1416080
Office Expansion Server Upgrade Present value of annual net cash flows 1,422,784 1,416,080 Less amount to be invested 1,345,000 1,345,000 Net present value 77,784 71,080Related Questions
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