Question

Vanderheiden Inc. is considering two average-risk alternative ways of producing its patented polo shirts. Process S has a cost of $9,000 and will produce net cash flows of $6,000 per year for 2 years. Process L will cost $14,500 and will produce cash flows of $5,000 per year for 4 years. The company has a contract that requires it to produce the shirts for 4 years, but the patent will expire after 4 years, so the shirts will not be produced after 4 years. If cash inflows occur at the end of each year, and if Vanderheiden's cost of capital is 10 percent, What is the NPV of the better project? What is the better project? By what amount will the better project increase Vanderheiden's value? (Show work in excel)

Answer 1

	S	L
0	-9000	-14500
1	6000	5000
2	-3000	5000
3	6000	5000
4	6000	5000
NPV	$2,581.18	$1,349.33
Difference	$1,231.85

For Process S, we will have to repeat the investment in order to make sure that the process last for 4 years.

Tabulate the cash flows for both processes as shown above.

NPV can be calculated using NPV function in excel

NPV (S) = NPV(10%, 6000....6000) - 9000 = $2,581.18

NPV (L) = NPV(10%, 5000...5000) - 14,500 = $1,349.33

Process S is better as it has higher NPV.