Question

1. Starry Night Café is considering the purchase of new equipment that would cost them $50,000. You have estimated that the new equipment would generate the following cash inflows for the next four years: (7 points)

	Cash Inflows
Year 1	$       10,000
Year 2	$       15,000
Year 3	$       15,000
Year 4	$       25,000

1. Calculate the net present value of this investment by using a discount rate of 9% and the P.V. Table depicted below:

Present Value of $1
	5%	6%	7%	8%	9%	10%
1	0.952	0.943	0.935	0.926	0.917	0.909
2	0.907	0.890	0.873	0.857	0.842	0.826
3	0.864	0.840	0.816	0.794	0.772	0.751
4	0.823	0.792	0.763	0.735	0.708	0.683
5	0.784	0.747	0.713	0.681	0.650	0.621

2. Was the present value of a lump sum or an annuity used in this problem and why?
3. What is the profitability index for this investment?
4. If the café compared the profitability index in (b.) to another investment that yields 1.2. Which option would you decide to invest in and why?

Answer 1

	Years	Net Cash Flows	PV of 1 at 9%	PV of Net Cash Flows
	1	$                                                  10,000	0.917	$                       9,170
	2	$                                                  15,000	0.842	$                     12,630
	3	$                                                  15,000	0.772	$                     11,580
	4	$                                                  25,000	0.708	$                     17,700
	Totals	$                                                  65,000		$                     51,080
	Amount Invested			$                     50,000
	Net Present Value			$                       1,080
a	Present Value on lump sum has been used in this problem as the Net cash flows are different for each year
b	Profitability Index =$51,080 / $50,000 =1.02
c	Since the Profitability Index of other investment is more than the current investment hence the other investment will be selected