Question

Harper Mining Ltd is considering to invest in one of the two following equipment. Each equipment will last 5 years and have no salvage value at the end. The company’s required rate of return for all investment projects is 7%. The cash flows of the projects are provided below. Equipment 1 Equipment 2 Cost $150,000 $165,000 Future Cash Flows Year 1 Year 2 Year 3 Year 4 Year 5 56,000 53,000 65,000 55,000 43,000 67,000 74,000 62,000 65,000 53,000 Required: a) Identify which option of equipment should the company accept based on net present value (NPV) method. (Note: All answers should be rounded up to 2 decimal places) ANSWER: b) Identify which option of equipment should the company accept based on discounted pay back method. ANSWER:

Answer 1

REQUIRED RATE OF RETURN-7%

Present value of cash out flow for equipment -1	150,000
Present value of cash out flow for equipment -2	165,000
Calculation of Present Value of Cash Inflows
Year	Cash Inflow For EQ-1	PV Of Cash Inflow for EQ-1	Cash Inflow For EQ-2	PV Of Cash Inflow for EQ-2
1	56,000.00	52336.45	67,000.00	62616.82
2	53,000.00	46292.25	74,000.00	64634.47
3	65,000.00	53059.36	62,000.00	50610.47
4	55,000.00	41959.24	65,000.00	49588.19
5	43,000.00	30658.41	53,000.00	37788.27
Total	272,000.00	224,305.71	321,000.00	265,238.22

NPV OF EQUIPMENT-1

PV OF CASH INFLOW- 224305.71

PV OF CASH OUTFLOW-150000

NET PRESENT VALUE-74301.71

NPV OF EQUIPMENT-2

PV OF CASH INFLOW- 265238.22

PV OF CASH OUTFLOW-165000

NET PRESENT VALUE-100238.22

AS PER NPV METHOD EQUIPMENT-2 GETS MORE RETURNS, SO IT IS BETTER TO PURCHASE EQUIPMENT-2.

Calculation of Discounting Payback Period.

Calculation of Discounting Payback Period
Year	PV Of Cash Inflow for EQ-1	Net Invested Cash
0	0	150000
1	52336.45	97663.55
2	46292.25	51371.3
3	53059.36
4	41959.24
5	30658.41
NET VALUE REQUIRED DURING THE 3RD YEAR	51371.3

The table indicates that the real payback period is located somewhere between Year 2 and Year 3

There is 51371.3 of investment yet to be paid back at the end of Year 2, and there is 53059.36 of cash flow projected for Year 3. We assumes the same monthly amount of cash flow in Year 3, which means that he can estimate final Discounting payback as being just short of 2.11 years.

Calculation of Discounting Payback Period for EQ-2
Year	PV Of Cash Inflow for EQ-2	Net Invested Cash
0	0	165000
1	62616.82	102383.18
2	64634.47	37748.71
3	50610.47
4	49588.19
5	37788.27
NET VALUE REQUIRED DURING THE 3RD YEAR	37,748.71

The table indicates that the real payback period is located somewhere between Year 2 and Year 3

There is 37748.71 of investment yet to be paid back at the end of Year 2, and there is 50610.47 of cash flow projected for Year 3. We assumes the same monthly amount of cash flow in Year 3, which means that he can estimate final Discounting payback as being just short of 2.9 years.

Therefore, As per Discounting Payback Period method, it is better to purchase Equipment-2, Because EQ-2 Contains lower Payback Period.