Question

JBL Co. has designed a new conveyor system. Management must choose among the three alternative courses of actions : (1) The firm can sell the design outright to another corporation with payment over two years (2) It can license the design to another manufacturer for a period of 5 years, it it likely product life. (3) It can manufacture and market the system itself; this alternative will result in 6 years of cash inflows. The company has a cost of capital of 12%. Cash flows associated with each alternative are as follows;

Alternative	Sell	License	Manufacture
Initial investment (CF0)	$ 200,000	$ 200,000	$ 450,000
Year	Cash inflow
1	200,000	250,000	200,000
2	250,000	100,000	250,000
3	-	80,000	200,000
4	-	60,000	200,000
5	-	40,000	200,000
6	-	-	200,000

Calculate the net present value of each alternative and rank the alternatives on the basis of NPV?

Calculate the annualized net present value (ANVP) of each alternative and rank them accordingly?

Why ANPV preferred over NPV when ranking projects with unequal lives?

Answer 1

(a)-Net Present Value & Ranking based on NPV

Alternative - SELL

Year	Annual Cash Flow	Present Value factor at 12%	Present Value of Cash Flow
1	2,00,000	0.89286	1,78,571.43
2	2,50,000	0.79719	1,99,298.47
TOTAL		1.69005	3,77,869.90

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $3,77,869.90 - $200,000

= $1,77,869.90

Alternative – License

Year	Annual Cash Flow	Present Value factor at 12%	Present Value of Cash Flow
1	2,50,000	0.89286	2,23,214.29
2	1,00,000	0.79719	79,719.39
3	80,000	0.71178	56,942.42
4	60,000	0.63552	38,131.08
5	40,000	0.56743	22,697.07
TOTAL		3.60478	4,20,704.25

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $4,20,704.25 - $200,000

= $2,20,704.25

Alternative – Manufacture

Year	Annual Cash Flow	Present Value factor at 12%	Present Value of Cash Flow
1	2,00,000	0.89286	1,78,571.43
2	2,50,000	0.79719	1,99,298.47
3	2,00,000	0.71178	1,42,356.05
4	2,00,000	0.63552	1,27,103.62
5	2,00,000	0.56743	1,13,485.37
6	2,00,000	0.50663	1,01,326.22
TOTAL		4.11141	8,62,141.16

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $8,62,141.16 - $450,000

= $4,12,141.16

Ranking of Machine Based on NPV

Sell – RANK 3

License – RANK 2

Manufacture – RANK 1

(b)-Annualized Net Present Value (ANPV) & Ranking based on ANPV

Alternative – SELL

Annualized Net Present Value (ANPV) = Net Present Value / [PVIFA 12%, 2 Years]

= $1,77,869.90 / 1.69005

= $1,05,245.28

Alternative – License

Annualized Net Present Value (ANPV) = Net Present Value / [PVIFA 12%, 5 Years]

= $2,20,704.25 / 3.60478

= $61,225.51

Alternative – Manufacture

Annualized Net Present Value (ANPV) = Net Present Value / [PVIFA 12%, 6 Years]

= $4,12,141.16 / 4.11141

= $1,00,243.33

Ranking based on ANPV

Sell – RANK 1

License – RANK 3

Manufacture – RANK 2

Analysis

The Annualized Net Present Value (ANPV) should be always preferred if the Projects has the different lives or unequal lives. Since, the ANPV gives the exact annual net worth of the project whereas the NPV shows the total worth to the shareholders.