Question

Cullumber 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 9 percent discount rate for production system projects.

Year			System 1			System 2
0			-$13,000			-$42,600
1			13,000			33,900
2			13,000			33,900
3			13,000			33,900

Calculate NPV. (Enter negative amounts using negative sign, e.g. -45.25. Do not round discount factors. Round answers to 2 decimal places, e.g. 15.25.)

In which system should the firm invest?

Answer 1

System 1:

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=13000/1.09+13000/1.09^2+13000/1.09^3

=32906.83

NPV=Present value of inflows-Present value of outflows  

=32906.83-13000

=$19906.83(Approx)

System 2:

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=33900/1.09+33900/1.09^2+33900/1.09^3

=85810.89

NPV=Present value of inflows-Present value of outflows  

=85810.89-42600

=$43210.89(Approx)

Hence since projects are mutually exclusive;project having higher NPV must be selected ie System 2 must be selected.