Question

Alternative Capital Investments

Alternative Capital Investments The investment committee of Sentry Insurance Co. is evaluating two projects, office expansion and upgrade to computer servers. The projects have different useful lives, but each requires an investment of $1,290,000. The estimated net cash flows from each project are as follows: Net Cash Flow Year Office Expansion Server $339,000 339,000 339,000 339,000 339,000 339,000 $447,000 447,000 447,000 447,000 The committee has selected a rate of 12% for purposes of net present value analysis. It also estimates that the residual value at the end of each project's useful life is $0, but at the end of the fourth year, the office expansion's residual value would be $424,000. Present Value of $1 at Compound Interest Year 6% 10% 12% 15% 20% 0.943 0.909 0 .893 0.870 0.833 0.890 0.826 0.797 0.756 0.694 0.840 0.751 0.712 0.658 0.579 0.792 0.683 0.636 0.572 0.482 5 0.747 0.621 0.567 0.497 0.402 IN

Answer 1

- A The investment co sentary Insurance co Real I Expansion present value of annual nel cash How ss 1.393 629 Less: Amount to be invested 16290000) Net present value S103629 seves upgrade 1 357539 (1, 290,000) $ 67539 present value: I office Expansion : CR=12% N=6] 339000X 4.1 / 393 629 GILL (2) serves upgrage CR-127 N = 4] - 3.037 14, 47000 X 3.037 =) - 1357539 Reg 2 Present value of net cash flow TOTAL less: Amount to be invested Net present volue $ office Expansion 11299 546 (1290,000) 9546 seres upgrade 1,357 986 (1,290,000) $ 67986 IPV of Net cash flow present value of yeas $ 10121 offre EXP seive upga office server 0.893 $339000 447000 302727539914 0.497 339000 447000 270183 356259 10.712 $3,39000 447000 241368 318264 0.636 $339000 447000 215604 284292 y Residucu val) To 636 424000 o 269664o total 1780,000 1788,000 1299546 1,357986 Less: Amount to be invested (2.90 000) (1 290 000 Net present value T 9546 67986

3). The net present value of the two projects over equal lives indicates that the Server upgrade a higher net present value and would be a superior investment.