Question

Net Present Value and Competing Projects

For discount factors use Exhibit 12B.1 and Exhibit 12B.2.

Spiro Hospital is investigating the possibility of investing in new dialysis equipment. Two local manufacturers of this equipment are being considered as sources of the equipment. After-tax cash inflows for the two competing projects are as follows:

Year	Puro Equipment	Briggs Equipment
1	$320,000	$120,000
2	280,000	120,000
3	240,000	320,000
4	160,000	400,000
5	120,000	440,000

Required:

Round present value calculations and your final answers to the nearest dollar.

1. Assuming a discount rate of 16%, compute the net present value of each piece of equipment.

Puro equipment: $

Briggs equipment: $

2. A third option has surfaced for equipment purchased from an out-of-state supplier. The cost is also $560,000, but this equipment will produce even cash flows over its 5-year life. What must the annual cash flow be for this equipment to be selected over the other two? Assume a 16% discount rate.

$ 252,892 per year

Answer 1

Solution 1:

Computation of NPV
			Puro Equipment		Briggs Equipment
Particulars	Period	PV Factor (16%)	Amount	Present Value	Amount	Present Value
Cash outflows:
Cost of Equipment	0	1	$560,000	$560,000	$560,000	$560,000
Present Value of Cash outflows (A)				$560,000		$560,000
Cash Inflows
Year 1	1	0.86207	$320,000	$275,862	$120,000	$103,448
Year 2	2	0.74316	$280,000	$208,086	$120,000	$89,180
Year 3	3	0.64066	$240,000	$153,758	$320,000	$205,010
Year 4	4	0.55229	$160,000	$88,367	$400,000	$220,916
Year 5	5	0.47611	$120,000	$57,134	$440,000	$209,490
Present Value of Cash Inflows (B)				$783,206		$828,044
Net Present Value (NPV) (B-A)				$223,206		$268,044

Solution 2:

If surface for equipment has to be selected over the two, the it must provide present value of cash inflows equal to $828,044 so that it will have higher NPV.

Let annual cash inflow from this equipment is X

Now

X * Cumulative PV Factor at 16% for 5 periods = $828,044

X * 3.27429 = $828,044

X = $252,892

Therefore required annual cash flow from this equipment = $252,892