The Smith Pie Company is considering two mutually exclusive investments that wou

Question

The Smith Pie Company is considering two mutually exclusive investments that would increase its capacity to make strawberry tarts. The firm uses a 12 percent cost of capital to evaluate potential investments. The two projects have the following costs and cash flow streams. Using this data, calculate the net present value for Projects A and B. Create a replacement chain for Alternative A. Assume that the cost of replacing A will be $30,000 and that the replacement project will generate cash flows of $10,500 for years 5 through 8. Using these figures, recompute the net present value for Alternative A. Which of the two alternatives should be chosen, A or B? Why?

Explanation / Answer

a) Statemnet showing Cash flows Alternative A Alternative B Particulars Time PVf@12% Amount PV Amount PV Cash Outflows               -                     1.00              (30,000.00)         (30,000.00)     (30,000.00)     (30,000.00) PV of Cash outflows         (30,000.00)     (30,000.00) Cash inflows         1.00              0.8929                 10,500.00              9,375.00          6,500.00          5,803.57 Cash inflows         2.00              0.7972                 10,500.00              8,370.54          6,500.00          5,181.76 Cash inflows         3.00              0.7118                 10,500.00              7,473.69          6,500.00          4,626.57 Cash inflows         4.00              0.6355                 10,500.00              6,672.94          6,500.00          4,130.87 Cash inflows         5.00              0.5674                           -            6,500.00          3,688.27 Cash inflows         6.00              0.5066                           -            6,500.00          3,293.10 Cash inflows         7.00              0.4523                           -            6,500.00          2,940.27 Cash inflows         8.00              0.4039                           -            6,500.00          2,625.24 PV of Cash Inflows            31,892.17        32,289.66 NPV              1,892.17          2,289.66 b) Statemnet showing Cash flows Alternative A Particulars Time PVf@12% Amount PV Cash Outflows               -                     1.00              (30,000.00)         (30,000.00) Cash Outflows (Replacement)         4.00              0.6355              (30,000.00)         (19,065.54) PV of Cash outflows         (49,065.54) Cash inflows         1.00              0.8929                 10,500.00              9,375.00 Cash inflows         2.00              0.7972                 10,500.00              8,370.54 Cash inflows         3.00              0.7118                 10,500.00              7,473.69 Cash inflows         4.00              0.6355                 10,500.00              6,672.94 Cash inflows         5.00              0.5674                 10,500.00              5,957.98 Cash inflows         6.00              0.5066                 10,500.00              5,319.63 Cash inflows         7.00              0.4523                 10,500.00              4,749.67 Cash inflows         8.00              0.4039                 10,500.00              4,240.77 PV of Cash Inflows            52,160.22 NPV              3,094.68 c) In case of Option A,Alternative B should be chosen since it has higher NPV In case of Option B, Alternative A should be chosen since it has higher NPV

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