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Net Present Value-Unequal Lives Daisy’s Creamery Inc. is considering one of two investment options. Option 1...

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.)

Solutions

Expert Solution

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


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