Question

Dixie Dynamite Company is evaluating two methods of blowing up old buildings for commercial purposes over the next five years. Method one (implosion) is relatively low in risk for this business and will carry a 12 percent discount rate. Method two (explosion) is less expensive to perform but more dangerous and will call for a higher discount rate of 17 percent. Either method will require an initial capital outlay of $110,000. The inflows from projected business over the next five years are shown next.  
  

Years	Method 1			Method 2
1	$	33,800		$	18,800
2		33,200			29,500
3		42,100			38,100
4		34,800			38,600
5		19,200			71,200

   
Use Appendix B for an approximate answer but calculate your final answers using the formula and financial calculator methods.

a. Calculate net present value for Method 1 and Method 2. (Do not round intermediate calculations and round your answers to 2 decimal places.)
     
  
b. Which method should be selected using net present value analysis?

• Method 1

• Method 2

• Neither of these

Answer 1

Net Present Value (NPV) - Method 1 (Implosion)

Year	Annual cash inflow ($)	Present Value factor at 12.00%	Present Value of annual cash inflow ($)
1	33,800	0.892857	30,178.57
2	33,200	0.797194	26,466.84
3	42,100	0.711780	29,965.95
4	34,800	0.635518	22,116.03
5	19,200	0.567427	10,894.60
TOTAL			1,19,621.98

Net Present Value (NPV) of the Project = Present Value of annual cash inflows – Initial Investment

= $1,19,621.98 - $110,000

= $9,621.98

Net Present Value (NPV) - Method 2 (Explosion)

Year	Annual cash inflow ($)	Present Value factor at 17.00%	Present Value of annual cash inflow ($)
1	18,800	0.854701	16,068.38
2	29,500	0.730514	21,550.15
3	38,100	0.624371	23,788.52
4	38,600	0.533650	20,598.89
5	71,200	0.456111	32,475.11
TOTAL			1,14,481.05

Net Present Value (NPV) of the Project = Present Value of annual cash inflows – Initial Investment

= $1,14,481.05 - $110,000

= $4,481.05

DECISION

The “METHOD 1” should be selected by using net present value analysis, since it has the higher NPV of $9,621.98.

NOTE

The formula for calculating the Present Value Inflow Factor (PVIF) is [1 / (1 + r)ⁿ], where “r” is the Discount Rate/Cost of capital and “n” is the number of years.