In: Accounting
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 | $ | $ |
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