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 $665,159. The net cash flows estimated for the two proposals are as follows:

	Net Cash Flow
Year	Processing Mill		Electric Shovel
1	$203,000		$254,000
2	181,000		235,000
3	181,000		217,000
4	144,000		223,000
5	110,000
6	91,000
7	79,000
8	79,000

The estimated residual value of the processing mill at the end of Year 4 is $250,000.

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 10%. 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

Solution:

NPV of Processing Mill:
Year	Cash flow	@10%	Pv of CF
1	203000	0.909	184527
2	181000	0.826	149506
3	181000	0.751	135931
4	394000	0.683	269102	Includes Residual Value
5	110000	0.621	68310
6	91000	0.564	51324
7	79000	0.513	40527
8	79000	0.467	36893
Present value of cash flow	936120
Less: Initial investment	665159
Net present value	270961
NPV of Processing Mill= $270961
NPV of Electric Shovel:
Year	Cash flow	@10%	Pv of CF
1	254000	0.909	230886
2	235000	0.826	194110
3	217000	0.751	162967
4	223000	0.683	152309
Present value of cash flow	740272
Less: Initial investment	665159
Net present value	75113
NPV of Electric Shovel= $75113

Comment: Processing Mill project should be favoved since its NPV of processing mill i.e:$270961 is higher than NPV of electric shovel i.e; $75113. Hence, processing mill project is preferable.