Question

Keller Construction is considering two new investments. Project E calls for the purchase of earthmoving equipment. Project H represents an investment in a hydraulic lift. Keller wishes to use a net present value profile in comparing the projects. The investment and cash flow patterns are as follows: Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

Project E Project H

($35,000 investment) ($37,000 investment)

Year Cash Flow Year Cash Flow

1 $ 8,000 1 $ 19,000

2 13,000 2 16,000

3 19,000 3 15,000

4 21,000

a. Determine the net present value of the projects based on a zero percent discount rate.

Project E ___________

Project H ___________

b. Determine the net present value of the projects based on a discount rate of 13 percent. (Do not round intermediate calculations and round your answers to 2 decimal places.)

Project E ______

Project H _______

c. If the projects are not mutually exclusive, which project(s) would you accept if the discount rate is 13 percent?

Project E

Project H

Both H and E

Answer 1

NPV is the difference between the present value of cash inflows and the present value of cash outflows over a period of time.

For project E,

At r = 0%,

NPV_E = 8000 + 13000 + 19000 + 21000 - 35000 = $26,000

At r = 13%

For project H,

At r = 0%,

NPV_H = 19000 + 16000 + 15000 - 37000 = $13,000

At r = 13%

a) At r = 0%,

Project E, NPV = 26000

Project H, NPV = 13000

b) At r = 13%,

Project E, NPV = 8308.20

Project H, NPV = 2740.26

c) At 13% cost of capital, Project E has higher NPV and hence, we should accept Project E. This project would add higher value to firm (compared to Project H)