Question

Blossom Incorporated management is considering investing in two alternative production systems. The systems are mutually exclusive, and the cost of the new equipment and the resulting cash flows are shown in the accompanying table. The firm uses a 7 percent discount rate for production system projects. Year System 1 System 2 0 -$12,000 -$42,000 1 12,000 30,000 2 12,000 30,000 3 12,000 30,000 Calculate NPV. (Enter negative amounts using negative sign, e.g. -45.25. Do not round discount factors. Round answers to 2 decimal places, e.g. 15.25.)

NPV of System 1 is?  NPV of System 2 is ?

In which system should the firm invest? The firm should invest in __

Answer 1

System 1
Discount rate	7.000%
Year	0	1	2	3
Cash flow stream	-12000	12000	12000	12000
Discounting factor	1.000	1.070	1.145	1.225
Discounted cash flows project	-12000.000	11214.953	10481.265	9795.575
NPV = Sum of discounted cash flows
NPV System 1 =	19491.79
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

System 2
Discount rate	7.000%
Year	0	1	2	3
Cash flow stream	-42000	30000	30000	30000
Discounting factor	1.000	1.070	1.145	1.225
Discounted cash flows project	-42000.000	28037.383	26203.162	24488.936
NPV = Sum of discounted cash flows
NPV System 2 =	36729.48
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Invest in system 2 as it has higher NPV