Question

JBL Co. has designed a new conveyor system. Management must choose among the three alternative courses of actions : (1) The firm can sell the design outright to another corporation with payment over two years (2) It can license the design to another manufacturer for a period of 5 years, it it likely product life. (3) It can manufacture and market the system itself; this alternative will result in 6 years of cash inflows. The company has a cost of capital of 12%. Cash flows associated with each alternative are as follows;

Alternative	Sell	License	Manufacture
Initial investment (CF0)	-200000	-200000	-450000
Year	Cash inflow
1	200000	250000	200000
2	250000	100000	250000
3	-	80000	200000
4	-	60000	200000
5	-	40000	200000
6	-	-	200000
A. Calculate the net present value of each alternative and rank the alternatives on the basis of NPV?
B. Calculate the annualized net present value (ANVP) of each alternative and rank them accordingly?
C. Why ANPV preferred over NPV when ranking projects with unequal lives?
Please show work with formulas.

Answer 1

A. Computation of NPV of each alternative and ranking them.

Year	PVF @ 12% (A)	Annual cash inflows			Present value of cash inflows
		Sell (B)	License (C)	Manufacture (D)	Sell (A) x(B)	License (A) x(C)	Manufacture (A) x(D)
1	0.893	200,000	250,000	200,000	178,600	223,250	178,600
2	0.797	250,000	100,000	250,000	199,250	79,700	199,250
3	0.712		80,000	200,000		56,960	142,400
4	0.636		60,000	200,000		38,160	127,200
5	0.567		40,000	200,000		22,680	113,400
6	0.507			200,000			101,400
Total PV of cash inflows					377,850	420,750	862,250
Less: PV of cash outflows					- 200,000	- 200,000	- 450,000
NPV					177,850	220,750	412,250
RANK					3rd	2nd	1st

B. Computation of ANPV of each alternative and ranking them.

PVIFA @ 12% for 2 years = 0.893 + 0.797 = 1.690

PVIFA @ 12% for 5 years = 0.893 + 0.797 + 0.712 + 0.636 + 0.567 = 3.605

PVIFA @ 12% for 6 years = 0.893 + 0.797 + 0.712 + 0.636 + 0.567 + 0.507 = 4.112

RANKS

Sell = 1st

License = 3rd

Manufacture = 2nd

C. ANPV is preferred over NPV when ranking projects with unequal lives because it considers the concept of time value of money in a much better way and is able to give more accurate results for making decisions.