Question

Suppose you can choose between the following projects. Calculate Net Present Value for each and make a decision concerning which is best. Assume the relevant interest rate is 5%.

I. A die cast machine that costs $1,000.00 and provides an income stream of $200.00 per year for six years.

II. A plastic molding machine that costs $1,000.00 and provides an income stream of $250.00 per year for five years.

Better project is:

Its NPV is:

B) Suppose you are offered an alternate to the above projects: a perpetuity. What would the perpetuity payment have to be in order for you to be indifferent between it and the better project above? Required perpetuity payment:

Answer 1

(A) NPV is computed as follows.

NPV, Option I ($) = - 1,000 + 200 x PVIFA(5%, 6) = - 1,000 + 200 x 5.0757** = - 1,000 + 1,015.14 = 15.14

NPV, Option II ($) = - 1,000 + 250 x PVIFA(5%, 5) = - 1,000 + 250 x 4.3295** = - 1,000 + 1,082.38 = 82.38

Better project is Option II (Since it has higher NPV).

Its NPV = $82.38

(B) For indifference,

$82.38 = Initial cost + (Required payment / Interest rate)

$82.38 = - $1,000 + (Required payment / 0.05)

(Required payment / 0.05) = 1,082.38

Required payment = $1,082.38 x 0.05 = $54.12