Question

Cullumber Industries is expanding its product line and its production capacity. The costs and expected cash flows of the two independent projects are given in the following table. The firm uses a discount rate of 10.54 percent for such projects.

Year		Product Line Expansion			Production Capacity Expansion
0		-$3,146,400			-$9,369,900
1		741,600			2,699,400
2		895,900			2,699,400
3		895,900			2,699,400
4		895,900			3,978,600
5		895,900			3,978,600

a. What are the NPVs of the two projects? (Enter negative amounts using negative sign, e.g. -45.25. Do not round discount factors. Round other intermediate calculations and final answer to 0 decimal places, e.g. 1,525.)

NPV of product line expansion is		$
NPV of production capacity expansion is		$

b. Should both projects be accepted? or either? or neither? Explain your reasoning.

Cullumber should accept only the production capacity expansionboth projectsneither projectonly the product line expansion .

Answer 1

NPV of product line expansion

Year	Annual cash flows ($)	Present Value Factor (PVF) at 10.54%	Present Value of annual cash flows ($) [Annual cash flow x PVF]
1	741,600	0.9046499	670,888
2	895,900	0.8183914	733,197
3	895,900	0.7403577	663,286
4	895,900	0.6697646	600,042
5	895,900	0.6059024	542,828
TOTAL		3,210,242

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

= $3,210,242 - $3,146,400

= $63,842

NPV of production capacity expansion

Year	Annual cash flows ($)	Present Value Factor (PVF) at 10.54%	Present Value of annual cash flows ($) [Annual cash flow x PVF]
1	2,699,400	0.9046499	2,442,012
2	2,699,400	0.8183914	2,209,166
3	2,699,400	0.7403577	1,998,522
4	3,978,600	0.6697646	2,664,725
5	3,978,600	0.6059024	2,410,643
TOTAL		11,725,068

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

= $11,725,068 - $9,369,900

= $2,355,168

NPV of product line expansion is $63,842

NPV of production capacity expansion is $2,355,168

DECISION

Since,it is an independent projects, Cullumber can accept either both projects, because the NPV for the both projects are positive.

NOTE    

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.