Question

Net Present Value—Unequal Lives

Gold Creek Mining Company has two competing proposals: a processing mill and an electric shovel. Both pieces of equipment have an initial investment of $440,874. The net cash flows estimated for the two proposals are as follows:

	Net Cash Flow
Year	Processing Mill		Electric Shovel
1	$150,000		$188,000
2	134,000		174,000
3	134,000		161,000
4	107,000		165,000
5	81,000
6	68,000
7	59,000
8	59,000

The estimated residual value of the processing mill at the end of Year 4 is $190,000.

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

Determine which equipment should be favored, comparing the net present values of the two proposals and assuming a minimum rate of return of 15%. Use the present value table appearing above.

	Processing Mill	Electric Shovel
Present value of net cash flow total	$	$
Less amount to be invested	$	$
Net present value	$	$

Which project should be favored?

Answer 1

Statement showing Cash flows			Processing Mill		Electric Shovel
Particulars	Time	PVf 15%	Amount	PV
Cash Outflows	-	1.00	(440,874.00)	(440,874.00)	(440,874.00)	(440,874.00)
PV of Cash outflows = PVCO				(440,874.00)		(440,874.00)
Cash inflows	1.00	0.8700	150,000.00	130,500.00	188,000.00	163,560.00
Cash inflows	2.00	0.7560	134,000.00	101,304.00	174,000.00	131,544.00
Cash inflows	3.00	0.6580	134,000.00	88,172.00	161,000.00	105,938.00
Cash inflows	4.00	0.5720	107,000.00	61,204.00	165,000.00	94,380.00
Cash inflows - Residual Value	4.00	0.5720	190,000.00	108,680.00		-
PV of Cash Inflows =PVCI				489,860.00		495,422.00
NPV= PVCI - PVCO				48,986.00		54,548.00
Electric shovel should be preferred since it has higher NPV