The investment committee of Safe Hands Insurance Co. is evaluating two projects. The projects have different useful lives, but each requires an investment of $225,000. The estimated net cash flows from each project are as follows: Net Cash Flows Year Project I Project II 1 $70,000 $98,000 2 70,000 98,000 3 70,000 98,000 4 70,000 98,000 5 70,000 6 70,000 The committee has selected a rate of 12% for purposes of net present value analysis. It also estimates that the residual value at the end of each project’s useful life is $0, but at the end of the fourth year, Project I’s residual value would be $150,000. Instructions 1. For each project, compute the net present value. Use the present value of an annuity of $1 table appearing in this chapter. (Ignore the unequal lives of the projects.) 2. For each project, compute the net present value, assuming that Project I is adjusted to a four-year life for purposes of analysis. Use the present value of $1 table appearing in this chapter. 3. Prepare a report to the investment committee, providing your advice on the relative merits of the two projects.
The investment committee of Safe Hands Insurance Co. is evaluating two projects. The projects have different useful lives, but each requires an investment of $225,000. The estimated net cash flows from each project are as follows:
|
|
Net Cash Flows |
|
|
Year |
Project I |
Project II |
|
1 |
$70,000 |
$98,000 |
|
2 |
70,000 |
98,000 |
|
3 |
70,000 |
98,000 |
|
4 |
70,000 |
98,000 |
|
5 |
70,000 |
|
|
6 |
70,000 |
|
The committee has selected a rate of 12% for purposes of net present value analysis. It also estimates that the residual value at the end of each project’s useful life is $0, but at the end of the fourth year, Project I’s residual value would be $150,000.
Instructions
1. For each project, compute the net present value. Use the present value of an annuity of $1 table appearing in this chapter. (Ignore the unequal lives of the projects.)
2. For each project, compute the net present value, assuming that Project I is adjusted to a four-year life for purposes of analysis. Use the present value of $1 table appearing in this chapter.
3. Prepare a report to the investment committee, providing your advice on the relative merits of the two projects.
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