Question

Unequal liveslong dash—ANPV approach  

JBL Co. has designed a new conveyor system. Management must choose among three alternative courses of​ action: (1) The firm can sell the design outright to another corporation with payment over 2years.​ (2) It can license the design to another manufacturer for a period of 5years, its likely product life.​ (3) It can manufacture and market the system​ itself; this alternative will result in 6years of cash inflows. The company has a cost of capital of 11.3 %.Cash flows associated with each alternative are as shown in the following table.  ​(Click on the icon here order to copy the contents of the data table below into a​ spreadsheet.)

Alternative	Sell	License	Manufacture
Initial investment ​(CF 0CF0​)	​$199,300	​$199,400	​$449,700
Year ​(tt ​)	Cash inflows ​(CF Subscript tCFt​)
1	​$200,700	​$250,000	​$199,100
2	249,000	99,600	245,000
3		79,800	199,100
4		60,000	199,100
5		41,000	199,100
6			199,100

a. Calculate the net present value of each alternative and rank the alternatives on the basis of NPV.

b. Calculate the annualized net present value​ (ANPV) of each alternative and rank them accordingly.

c.  Why is ANPV preferred over NPV when ranking projects with unequal​ lives?

Answer 1

Solution a) The cash flows are shown as follows:

Based upon the NPV, the rankings are as follows:

Solution b) Present value annuity factor (PVIAF) = [1 - (1+r)^-n]/r

For Sell, PVIAF = [1 - (1+11.3%)^-2]/11.3%

= [1 - 0.807253]/11.3%

= 1.705726

For License, PVIAF = [1 - (1+11.3%)^-5]/11.3%

= [1 - 0.585496]/11.3%

= 3.668174

For Manufacture, PVIAF = [1 - (1+11.3%)^-6]/11.3%

= [1 - 0.526052]/11.3%

= 4.194226

The ANPV is calculated as follows:

Ranking based upon ANPV is as follows:

Solution c) Comparing the NPVs of projects with unequal lives gives an advantage to those projects that generate cash flows over the longer period. ANPV adjusts for the differences in the length of the projects and allows selection of the optimal project. This technique implicitly assumes that all projects can be selected again at their conclusion an infinite number of times.