Dixie Dynamite Company is evaluating two methods of blowing up
old buildings for commercial purposes over the next five years.
Method one (implosion) is relatively low in risk for this business
and will carry a 12 percent discount rate. Method two (explosion)
is less expensive to perform but more dangerous and will call for a
higher discount rate of 17 percent. Either method will require an
initial capital outlay of $80,000. The inflows from projected
business over the next five years are shown next.
Years | Method 1 | Method 2 | ||||
1 | $ | 31,700 | $ | 19,800 | ||
2 | 36,800 | 30,600 | ||||
3 | 46,900 | 34,500 | ||||
4 | 35,200 | 34,700 | ||||
5 | 26,500 | 70,400 | ||||
Use Appendix B for an approximate answer but calculate your final
answers using the formula and financial calculator methods.
Calculation of NPV of Project using method 1 and 2:
NPV = Present value of cash inflows- initial outlays
Method 1:
Year |
Cash Inflows |
P.V. factor @ 12% discounting rate |
P.V. of Cash inflows |
1 |
31700 |
0.8929 |
28303.58 |
2 |
36800 |
0.7972 |
29336.73 |
3 |
46900 |
0.7118 |
33382.49 |
4 |
35200 |
0.6355 |
22370.24 |
5 |
26500 |
0.5674 |
15036.81 |
P.V. of total cash inflows |
128429.85 |
= $128429.85-$80000
= $48429.85
Year |
Cash Inflows |
P.V. factor @ 17% discounting rate |
P.V. of Cash inflows |
1 |
19800 |
0.8547 |
16923.08 |
2 |
30600 |
0.7305 |
22353.71 |
3 |
34500 |
0.6244 |
21540.78 |
4 |
34700 |
0.5337 |
18517.66 |
5 |
70400 |
0.4561 |
32110.23 |
P.V. of total cash inflows |
111445.46 |
= $111445.46-$80000
= $31445.46
Since NPV through Method 2 is higher than Method 1 therefore, Method 2 should be obtained.
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