Question

In: Accounting

The investment committee of Sentry Insurance Co. is evaluating two projects, office expansion and upgrade to...

The investment committee of Sentry Insurance Co. is evaluating two projects, office expansion and upgrade to computer servers. The projects have different useful lives, but each requires an investment of $1,117,000. The estimated net cash flows from each project are as follows:

Net Cash Flow
Year     

Office Expansion

    

Server

1 $312,000 $412,000
2 312,000 412,000
3 312,000 412,000
4 312,000 412,000
5 312,000
6 312,000

The committee has selected a rate of 15% for purposes of net present value analysis. It also estimates that the residual value at the end of each project's useful life is $0, but at the end of the fourth year, the office expansion's residual value would be $390,000.

Present Value of $1 at Compound Interest
Year 6% 10% 12% 15% 20%
1 0.943 0.909 0.893 0.870 0.833
2 0.890 0.826 0.797 0.756 0.694
3 0.840 0.751 0.712 0.658 0.579
4 0.792 0.683 0.636 0.572 0.482
5 0.747 0.621 0.567 0.497 0.402
6 0.705 0.564 0.507 0.432 0.335
7 0.665 0.513 0.452 0.376 0.279
8 0.627 0.467 0.404 0.327 0.233
9 0.592 0.424 0.361 0.284 0.194
10 0.558 0.386 0.322 0.247 0.162
Present Value of an Annuity of $1 at Compound Interest
Year 6% 10% 12% 15% 20%
1 0.943 0.909 0.893 0.870 0.833
2 1.833 1.736 1.690 1.626 1.528
3 2.673 2.487 2.402 2.283 2.106
4 3.465 3.170 3.037 2.855 2.589
5 4.212 3.791 3.605 3.352 2.991
6 4.917 4.355 4.111 3.784 3.326
7 5.582 4.868 4.564 4.160 3.605
8 6.210 5.335 4.968 4.487 3.837
9 6.802 5.759 5.328 4.772 4.031
10 7.360 6.145 5.650 5.019 4.192

Required:

If required, use the minus sign to indicate a negative net present value.

1. For each project, compute the net present value. Use the present value of an annuity of $1 table above. Ignore the unequal lives of the projects. If required, round to the nearest dollar.

Office Expansion Server Upgrade
Present value of annual net cash flows $ $
Less amount to be invested $ $
Net present value $ $

2. For each project, compute the net present value, assuming that the office expansion is adjusted to a four-year life for purposes of analysis. Use the present value of $1 table above.

Office Expansion Server Upgrade
Present value of net cash flow total $ $
Less amount to be invested $ $
Net present value $ $

Solutions

Expert Solution

1.Net present value = present value of cash inflows – present value of cash outflows

Present value of cash inflows:

Office Expansion = 312,000*PVAF(15%, 6 years)

= 312,000*3.785 = $1,180,920

Server = 412,000*PVAF(15%, 4 years)

= 412,000*2.856 = $1,176,672

Office Expansion

Server Upgrade

Present value of annual net cash flows

$1,180,920

$1,176,672

Less amount to be invested

$1,117,000

$1,117,000

Net present value

$63,920

$59,672

2.

Office Expansion

Server Upgrade

Present value of annual net cash flows

$1,114,152

$1,176,672

Less amount to be invested

$1,117,000

$1,117,000

Net present value

$(2,848)

$59,672

Present value of inflows of office expansion = 312,000*2.856 + 390,000*0.572


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