Question

Net Present Value-Unequal Lives

Daisy’s Creamery Inc. is considering one of two investment options. Option 1 is a $69,000 investment in new blending equipment that is expected to produce equal annual cash flows of $21,000 for each of seven years. Option 2 is a $79,000 investment in a new computer system that is expected to produce equal annual cash flows of $27,000 for each of five years. The residual value of the blending equipment at the end of the fifth year is estimated to be $14,000. The computer system has no expected residual value at the end of the fifth year.

Present Value of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	0.890	0.826	0.797	0.756	0.694
3	0.840	0.751	0.712	0.658	0.579
4	0.792	0.683	0.636	0.572	0.482
5	0.747	0.621	0.567	0.497	0.402
6	0.705	0.564	0.507	0.432	0.335
7	0.665	0.513	0.452	0.376	0.279
8	0.627	0.467	0.404	0.327	0.233
9	0.592	0.424	0.361	0.284	0.194
10	0.558	0.386	0.322	0.247	0.162

Present Value of an Annuity of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	1.833	1.736	1.690	1.626	1.528
3	2.673	2.487	2.402	2.283	2.106
4	3.465	3.170	3.037	2.855	2.589
5	4.212	3.791	3.605	3.352	2.991
6	4.917	4.355	4.111	3.784	3.326
7	5.582	4.868	4.564	4.160	3.605
8	6.210	5.335	4.968	4.487	3.837
9	6.802	5.759	5.328	4.772	4.031
10	7.360	6.145	5.650	5.019	4.192

Assume there is sufficient capital to fund only one of the projects. Determine which project should be selected, comparing the (a) net present values and (b) present value indices of the two projects, assuming a minimum rate of return of 12%. Use the present value tables appearing above.

a. Determine the net present values of the two projects.

	Blending Equipment	Computer System
Total present value of cash flows	$	$
Less amount to be invested	$	$
Net present value	$	$

b. Determine the present value indices of the two projects. If required, round the present value index to two decimal places.

	Present Value Index
Blending Equipment
Computer System

Which project should be selected? (If both present value indices are the same, either project will grade as correct.)

Answer 1

Computation of Present Value of Project Blending Department
Project	Particular	Amount	Time	PVAF@12%	PV
Blending	Annual CFAT	21,000	1-5	3.605	75,705
	Residual Value	14,000	5	0.567	7,938
	Total Present Value				83,643
Ccomputer	Annual CFAT	27,000	1-5	3.605	97,335
	Residual Value	-
	Total Present Value				97,335

a. NPV of Two projects
	Blending	Computer
PV of Cash Flow	83,643	97,335
Less: Amount Invested	69,000	79,000
NPV	14,643	18,335

b. Computation of PV Index
	Blending	Computer
PV of Cash Flow	83,643	97,335
Amount Invested	69,000	79,000
PV Index	1.21	1.23

Computer Project should be accepted