Question

Crane Incorporated management is considering investing in two alternative production systems. The systems are mutually exclusive, and the cost of the new equipment and the resulting cash flows are shown in the accompanying table. The firm uses a 8 percent discount rate for production system projects.

YearSystem 1System 2

0

-$12,900-$43,800

1

12,900 32,500

2

12,900 32,500

3

12,900 32,500

Answer 1

System 1: NPV is calculated below:

Year	CF	Discount Factor		Discounted CF
0	$            -12,900.00	1/(1+0.08)^0=	1	1*-12900=	$            -12,900.00
1	$             12,900.00	1/(1+0.08)^1=	0.925925926	0.925925925925926*12900=	$             11,944.44
1	$             12,900.00	1/(1+0.08)^1=	0.925925926	0.925925925925926*12900=	$             11,944.44
3	$             12,900.00	1/(1+0.08)^3=	0.793832241	0.79383224102017*12900=	$             10,240.44
				NPV = Sum of all Discounted CF	$             21,229.32

System 2: NPV is calculated below:

Year	CF	Discount Factor		Discounted CF
0	$            -43,800.00	1/(1+0.08)^0=	1	1*-43800=	$            -43,800.00
1	$             32,500.00	1/(1+0.08)^1=	0.925925926	0.925925925925926*32500=	$             30,092.59
2	$             32,500.00	1/(1+0.08)^2=	0.85733882	0.857338820301783*32500=	$             27,863.51
3	$             32,500.00	1/(1+0.08)^3=	0.793832241	0.79383224102017*32500=	$             25,799.55
				NPV = Sum of all Discounted CF	$             39,955.65

As NPV of system 2 is greater than that of NPV 1 so system 2 should be selected.