Question

Net Present Value—Unequal Lives

Bunker Hill Mining Company has two competing proposals: a processing mill and an electric shovel. Both pieces of equipment have an initial investment of $681,948. The net cash flows estimated for the two proposals are as follows:

	Net Cash Flow
Year	Processing Mill		Electric Shovel
1	$218,000		$273,000
2	194,000		253,000
3	194,000		233,000
4	155,000		240,000
5	118,000
6	98,000
7	85,000
8	85,000

The estimated residual value of the processing mill at the end of Year 4 is $270,000.

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

Determine which equipment should be favored, comparing the net present values of the two proposals and assuming a minimum rate of return of 12%. Use the present value table appearing above.

	Processing Mill	Electric Shovel
Present value of net cash flow total	$	$
Less amount to be invested
Net present value	$	$

Which project should be favored?

Answer 1

ANSWER

Net present value

	Processing Mill	Electric Shovel
Present value of net cash flow total	947,072	763,966
Less amount to be invested	681,948	681,948
Net present value	265,124	82,018

Present value annual cash flow – Processing Mill

Year	Annual cash flows ($)	Present Value Factor (PVF) at 12.00%	Present Value of annual cash flows ($) [Annual cash flow x PVF]
1	218,000	0.893	194,674
2	194,000	0.797	154,618
3	194,000	0.712	138,128
4	425,000 [155,000 + 270,000]	0.636	270,300
5	118,000	0.567	66,906
6	98,000	0.507	49,686
7	85,000	0.452	38,420
8	85,000	0.404	34,340
TOTAL		947,072

Present value annual cash flow – Electric Shovel

Year	Annual cash flows ($)	Present Value Factor (PVF) at 12.00%	Present Value of annual cash flows ($) [Annual cash flow x PVF]
1	273,000	0.893	243,789
2	253,000	0.797	201,641
3	233,000	0.712	165,896
4	240,000	0.636	152,640
TOTAL		763,966

“Processing Mill” should be favored, since it has the higher Net present value.