Question

Net Present Value and Competing Projects For discount factors use Exhibit 12B.1 and Exhibit 12B.2. Spiro Hospital is investigating the possibility of investing in new dialysis equipment. Two local manufacturers of this equipment are being considered as sources of the equipment. After-tax cash inflows for the two competing projects are as follows:

Year		Puro Equipment		Briggs Equipment
1		$320,000		$120,000
2		280,000		120,000
3		240,000		320,000
4		160,000		400,000
5		120,000		440,000

Both projects require an initial investment of $560,000. In both cases, assume that the equipment has a life of 5 years with no salvage value.

Required:

Round present value calculations and your final answers to the nearest dollar.

1. Assuming a discount rate of 8%, compute the net present value of each piece of equipment.

Puro equipment:	$
Briggs equipment:	$

2. A third option has surfaced for equipment purchased from an out-of-state supplier. The cost is also $560,000, but this equipment will produce even cash flows over its 5-year life. What must the annual cash flow be for this equipment to be selected over the other two? Assume a 8% discount rate.
$ per year

Answer 1

Ans. 1: Computation of Net Present Value (NPV) :

                                                                 

                                                                                Puro                              Briggs

                                                                        Equipment                             Equipments                                                                  Discounting                   Present Value              Present value of                   

                                        Factor @ 8%                   of Cash flows               Cash flows

                                       -------------                            ------------                       ----------------

Initial outlay    (A)                 1                                   560000                            560000                  

                                                               ==============             ==================    

Year 1                             0.925                                 296000                               111000            

Year 2                            0.857                                  239960                               102840

Year 3                            0.793                                  190320                               253760

Year 4                           0.735                                   117600                               294000

Year 5                             0.681                                81720                                  299640

                                                                   -----------------------------        --------------------

Total discounted cash inflow (B)                    925600                            1061240                  

                                                                ============                      ==============                     

Net Present Value                 (B-A)                  365600                                    501240

                                                                         ===============                ===========

Ans-2:

Average Annual cash inflow = Total discounted cash inflow / Cumulative Discounting factor for 5 years

Average annual inflow from pure equipment = 925600/3.991 = 231922

Average annual inflow from Briggs Equipment = 1061240/3.991 = 265908

So, the third option must be able to generate annual cash inflow more than 231922 as compared to Pure Equipment and more than 265908 as compared to Briggs equipment.