Question

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 11 percent discount rate. Method two (explosion) is less expensive to perform but more dangerous and will call for a higher discount rate of 16 percent. Either method will require an initial capital outlay of $102,000. The inflows from projected business over the next five years are shown next.  
  

Years	Method 1			Method 2
1	$	32,100		$	17,600
2		38,500			25,500
3		47,800			40,400
4		35,100			37,000
5		20,600			72,200

a. Calculate net present value for Method 1 and Method 2. (Do not round intermediate calculations and round your answers to 2 decimal places.)
Method 1:

Method 2:
  
b. Which method should be selected using net present value analysis?

• Method 1

• Method 2

• Neither of these

Answer 1

Method 1:

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=32100/1.11+38500/1.11^2+47800/1.11^3+35100/1.11^4+20600/1.11^5

=130463.89

NPV=Present value of inflows-Present value of outflows

=130463.89-102000

=$28463.89(Approx)

Method 2:

Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period)

=17600/1.11+25500/1.11^2+40400/1.11^3+37000/1.11^4+72200/1.11^5

=133312.59

NPV=Present value of inflows-Present value of outflows

=133312.59-102000

=$31312.59(Approx)

Hence method 2 must be selected having higher NPV.