Question

Net Present Value—Unequal Lives

Bunker Hill Mining Company has two competing proposals: a processing mill and an electric shovel. Both pieces of equipment have an initial investment of $816,172. The net cash flows estimated for the two proposals are as follows:

	Net Cash Flow
Year	Processing Mill		Electric Shovel
1	$279,000		$349,000
2	248,000		324,000
3	248,000		299,000
4	198,000		307,000
5	151,000
6	126,000
7	109,000
8	109,000

The estimated residual value of the processing mill at the end of Year 4 is $350,000.

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

Processing Mill
year	Cash flow	Discount factor (15%)	Discounted cash flow
1	$279,000	0.87	242730
2	248,000	0.756	187488
3	248,000	0.658	163184
4	198,000	0.572	113256
5	151,000	0.497	75047
6	126,000	0.432	54432
7	109,000	0.376	40984
8	109,000	0.327	35643
total			912764
Electric Shovel
year	Cash flow	Discount factor (15%)	Discounted cash flow
1	$349,000	0.87	303630
2	324,000	0.756	244944
3	299,000	0.658	196742
4	307,000	0.572	175604
total			920920

	Processing Mill	Electric Shovel
Present value of net cash flow total	$912,764	$920,920
Less amount to be invested	$816,172	$816,172
Net present value	$96,592	$104,748

The company should select the project of Electric Shovel as its net present value is higher than processing mill project.