Question

Hugo Industries is considering investing in one of two capital investment alternatives. The first alternative is to automate the finishing and painting operations. This alternative will require an investment of $380,000. This alternative is expected to result in labor cost savings of $65,000 per year for each of the next 10 years. The second alternative is to invest in new machining equipment with a cost of $280,000. The new machining equipment will have a seven-year useful life and a $35,000 salvage value. The new machining equipment is expected to generate additional revenues of $60,000 per year for the next seven years. Hugo Industries desired rate of return is 10 percent.

Required:

1. Determine the net present value of each of the two capital investment alternatives.

2. Compute the present value index for each of the two alternatives.

3. Which investment alternative will yield the higher rate of return and why?

Answer 1

Question

Answer :

	Alternative			Alternative
	A	PV Factor			B
		10 %'
1	$65,000	0.909	$59,085		$60,000	$54,540
2	$65,000	0.826	$53,690		$60,000	$49,560
3	$65,000	0.751	$48,815		$60,000	$45,060
4	$65,000	0.683	$44,395		$60,000	$40,980
5	$65,000	0.62	$40,300		$60,000	$37,200
6	$65,000	0.564	$36,660		$60,000	$33,840
7	$65,000	0.513	$33,345		$95,000	$48,735
8	$65,000	0.466	$30,290
9	$65,000	0.424	$27,560
10	$65,000	0.385	$25,025
Total of cash inflow			$3,99,165			$3,09,915
Cash outflow			$3,80,000			$2,80,000
NPV			$19,165			$29,915
Present Value Index		$1.05			$1.11
yield on investment		5.04%			10.68%
Alternative B yield higher return because it will recoved the investment in
the lesser period and it will required lesser intial investment and it will also
have the salvage value of Machinery
Present value index	=	Present value of cash inflow/ intial invesment
yield on investment	=	NPV/ intial investmern *100