Question

The investment committee of Shield 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 $580,000. The estimated net cash flows from each project are as follows: Net Cash Flow Year Office Expansion Server Upgrade 1 $162,000 $214,000 2 162,000 214,000 3 162,000 214,000 4 162,000 214,000 5 162,000 6 162,000 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 $203,000.

Present Value of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.9434	0.9091	0.8929	0.8696	0.8333
2	0.8900	0.8265	0.7972	0.7561	0.6944
3	0.8396	0.7513	0.7118	0.6575	0.5787
4	0.7921	0.6830	0.6355	0.5718	0.4823
5	0.7473	0.6209	0.5674	0.4972	0.4019
6	0.7050	0.5645	0.5066	0.4323	0.3349
7	0.6651	0.5132	0.4523	0.3759	0.2791
8	0.6274	0.4665	0.4039	0.3269	0.2326
9	0.5919	0.4241	0.3606	0.2843	0.1938
10	0.5584	0.3855	0.3220	0.2472	0.1615

Present Value of an Annuity of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.9434	0.9091	0.8929	0.8696	0.8333
2	1.8334	1.7355	1.6901	1.6257	1.5278
3	2.6730	2.4868	2.4018	2.2832	2.1065
4	3.4651	3.1699	3.0374	2.8550	2.5887
5	4.2124	3.7908	3.6048	3.3522	2.9906
6	4.9173	4.3553	4.1114	3.7845	3.3255
7	5.5824	4.8684	4.5638	4.1604	3.6046
8	6.2098	5.3349	4.9676	4.4873	3.8372
9	6.8017	5.7590	5.3283	4.7716	4.0301
10	7.3601	6.1446	5.6502	5.0188	4.1923

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. Note: Round final answers to the nearest whole dollar. Office Expansion Server Upgrade Present value of net cash flow total $ $ Less amount to be invested $ $ Net present value $ $ 3. The net present value of the two projects over equal lives indicates that the has a higher net present value and would be a superior investment. Check My Work

Answer 1

Solution 1):

Calculation of Net present Value of Office Expansion

Initial Investment = $580,000

Year	Net Cash Inflows $	Present Value Factor @ 15%	Present Value of Net Cash Inflows $
1	1,62,000.00	0.869565	1,40,869.57
2	1,62,000.00	0.756144	1,22,495.27
3	1,62,000.00	0.657516	1,06,517.63
4	1,62,000.00	0.571753	92,624.03
5	1,62,000.00	0.497177	80,542.63
6	1,62,000.00	0.432328	70,037.07
		Total Value of Net Cash Inflows	6,13,086.20

Net present Value of Office Expansion = Total Value of Net Cash Inflows – Initial Investment

                                                                          = $613,086.20 - $580,000

                                                                          = $33,086.20

Calculation of Net present Value of Server Upgrade

Initial Investment = $580,000

Year	Net Cash Inflows $	Present Value Factor @ 15%	Present Value of Net Cash Inflows $
1	2,14,000.00	0.869565	1,86,086.96
2	2,14,000.00	0.756144	1,61,814.74
3	2,14,000.00	0.657516	1,40,708.47
4	2,14,000.00	0.571753	1,22,355.19
		Total Value of Net Cash Inflows	6,10,965.37

Net present Value of Server Upgrade = Total Value of Net Cash Inflows – Initial Investment

                                                                          = $610,965.37 - $580,000

                                                                          = $30,965.37

	Office Expansion	Server Upgrade
Initial Investment $	5,80,000.00	5,80,000.00
Duration (Years)	6	4
NPV $	33,086.20	30,965.37

Om comparing the NPV of the two proposals, the company should go for Office Expansion as it has a higher NPV.

Solution 2) Calculation of NPV of Office Expansion after adjusting the duration of the project to 4 years

Year	Net Cash Inflows $	Present Value Factor @ 15%	Present Value of Net Cash Inflows $
1	1,62,000.00	0.869565	1,40,869.57
2	1,62,000.00	0.756144	1,22,495.27
3	1,62,000.00	0.657516	1,06,517.63
4	3,65,000.00	0.571753	2,08,689.93
		Total Value of Net Cash Inflows	5,78,572.40

Note: The Cash Inflows for the fourth year also includes the Scrap value $203,000

Net present Value of Office Expansion after adjusting duration to 4 years

= Total Value of Net Cash Inflows – Initial Investment

= $5,78,572.40 - $580,000

= -$1427.60

	Office Expansion	Server Upgrade
Initial Investment $	5,80,000.00	5,80,000.00
Duration (Years)	4	4
NPV $	-1,427.60	30,965.37

If the Duration of the Office Expansion is adjusted to 4 years, then the company should go for Server Upgrade as the Net Present Value of Office Expansion is negative.