Question

Finance (Net Present Value):

1. A firm that purchases electricity from the local utility for $400,000 per year is considering installing a steam generator at a cost of $290,000. The cost of operating this generator would be $280,000 per year, and the generator will last for five years. If the firm buys the generator, it does not need to purchase any electricity from the local utility. The cost of capital is 15%. For the local utility option, consider five years of electricity purchases. For the generator option, assume immediate installation, with purchase and operating costs in the current year and operating costs continuing for the next four years. Assume payments under both options at the start of each year (i.e., immediate, one year from now,..., four years from now). What is the net present value of the more attractive choice? Please round your answer to the nearest dollar. Report the NPV of cost as a negative number.

2. A firm that purchases electricity from the local utility is considering installing a steam generator. A large generator costs $270,000 whereas a small generator costs $180,000. The cost of operating the generator would be $250,000 per year for the large and $275,000 for the small. Either generator will last for five years. The cost of capital is 12%. For each generator option, assume immediate installation, with purchase and operating costs in the current year and operating costs continuing for the next four years. Assume payments under both options at the start of each year (i.e., immediate, one year from now,..., four years from now). What is the net present value of the more attractive generator? Please round your answer to the nearest dollar. Report the NPV of cost as a negative number.

3. A prospective MBA student earns $45,000 per year in her current job and expects that amount to increase by 12% per year. She is considering leaving her job to attend business school for two years at a cost of $35,000 per year. She has been told that her starting salary after business school is likely to be $115,000 and that amount will increase by 11% per year. Consider a time horizon of 10 years, use a discount rate of 12%, and ignore all considerations not explicitly mentioned here. Assume all cash flows occur at the start of each year (i.e., immediate, one year from now, two years from now,..., nine years from now). Also assume that the choice can be implemented immediately so that for the MBA alternative the current year is the first year of business school. What is the net present value of the more attractive choice? Please round your answer to the nearest dollar.

Answer 1

Solution:

1.Calculation of Net Present Value:

Since all the cash flows occured at the begining of the year,hence we have to discount till 4th year.

Statement showing Net cash flow and its present value

Year	0	1	2	3	4
Saving in Elecrticity's Purchase cost	$400,000	$400,000	$400,000	$400,000	$400,000
Less:Cost of Geneartor	$290,000	-	-	-	-
Less:Operating Cost	$280,000	$280,000	$280,000	$280,000	$280,000
Net Cash flow(a)	-$170,000	$120,000	$120,000	$120,000	$120,000
Present value Factor @15%(b)	1	0.870	0.7561	0.6575	0.5718
Present Value(a*b)	-$170,000	$104,400	$90,732	$78,900	$68,616

Net Present Value=-$170,000+$104,400+$90,732+$78,900+$68,616

=$172,648