Question

Daisy's Creamery Inc. is considering one of two investment options. Option 1 is a $75,000 investment in new blending equipment that is expected to produce equal annual cash flows of $19,000 for each of seven years. Option 2 is a $90,000 investment in a new computer system that is expected to produce equal annual cash flows of $27,000 for each of five years. The residual value of the blending equipment at the end of the fifth year is estimated to be $15,000. The computer system has no expected residual value at the end of the fifth year.

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

Present Value of an Annuity of $1 at Compound Interest

Year 6% 10% 12% 15% 20%
1 0.943 0.909 0.893 0.870 0.833
2 1.833 1.736 1.690 1.626 1.528
3 2.673 2.487 2.402 2.283 2.106
4 3.465 3.170 3.037 2.855 2.589
5 4.212 3.791 3.605 3.352 2.991
6 4.917 4.355 4.111 3.784 3.326
7 5.582 4.868 4.564 4.160 3.605
8 6.210 5.335 4.968 4.487 3.837
9 6.802 5.759 5.328 4.772 4.031
10 7.360 6.145 5.650 5.019 4.192

Required:
a. Determine the net present values of the two projects.
b. Determine the present value indices of the two projects.

Answer 1

Missing part of question assumes minimum rate of return of 10%.

Use 5 years for both investments for comparison.

a. Net Present Value of Project 1

Present value of $19,000 annually over 5 years at 10% = 19,000 * 3.791

= $72,029

Present value of $15,000 residual value at 5th year at 10% = 15,000 * 0.621

= $9,315

Net Present value = 72,029 + 9,315 - 75,000

= $6,344

Net Present Value of Project 2

Present value of $27,000 over 5 years, 10% = 27,000 * 3.791

= $‭102,357‬

Net Present Value = ‭102,357‬ - 90,000

= $12,357

b. Present value indices

= Present value of cash inflows/ investments

Project 1 Project 2

= (72,029 + 9,315) / 75,000 = 102,357 / 90,000

= 1.08 = 1.14