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PR 26-5A Alternative capital investments OBJ. 3, 4 1. Server upgrade, The investment committee of Sentry Insurance Co. is evilfferent usef $11,105 office ex- project pansion and upgrade to computer servers. The projects lives, ful each requires an investment of $490,000. The estimated net cash are as follows: flows from 1305 Chapter 26 Capital Investment Analysis Net Cash Flows Office Expansion Servers $125,000 $16000 25,000 165,000 165,000 125,000 125,000 125,000 The committee has selected a rte of 12% for purposes of net present value analysis. It also estimates that the residual value at the end of each projects useful life is s0, but at the end of the fourth year, the office expansions residual value would be $180,000. Instructions 1. For each project, compute the net present value. Use the present value of an annuity of $1 table appearing in this chapter (Exhibit 5). (Ignore the unequal lives of the projects.) 2. For each project, compute the net present value, assuming that the office expansion is adjusted to a four-year life for purposes of analysis. Use the present value of $1 table appearing in this chapter (Exhibit 2) Prepare a report to the investment committee, giving your advice on the relative merits of the two projects.

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HI 32 2. Net Present Value Analysis Present Value of Net Cash Flow Net Cash Flow Present Value of $1 at 12% 35 36 37 38 39 40 41 Server Office Server Office Expansion Upgrade Expansion Upgrade Year 1 Year 2 Year 3 Year 4 Year 4 (resid. value) Total Amount to be invested Net present value 42 43 45 46 47 48 3 49 50 Key essay answer here] 51 52 53 56 57 58 Pr. 26-5A

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Answer #1

1. Provided both answers in one sheet

Net Present Value Analysis NPV Analysis Net Cash Flow PV of Cash Flow Office Office Expansion Annual Net Cash Flow Present Value of Annuity of $1 at 12% for 6 years Present Value of Annual Net cash flows Less Amount to be invested Net Present Value Server Upgrade Annual Net Cash Flow Present Value of Annuity of $1 at 12% for 4 years Present Value of Annual Net cash flows Less Amount to be invested Net Present Value 1,25,000.00 4.1114 $ 5,13,925.92 $ 4,90,000.00 S 23,925.92 Present Value of $1 at 12% Office Server Server Year 1 Year 2 Year 3 Year 4 Year 4 Total 0.8929 1,25,000.00 $1,65,000.00 1,11,607.14 1,47,321.43 0.7972 $ 1,25,000.00 1,65,000.00 99,649.23 1,31,536.99 0.7118 $ 1,25,000.00 $ 1,65,000.00 88,972.53 $ 1,17,443.74 0.6355 1,25.000.00 S 1,65,000.00$ 79,439.76$ 1,04,860.48 0.6355$ 1,80,000.00 $ 6,80,000.00 $ 1,14,393.25 $ S 1,65,000.00 3.0373 5,01,162.64 $ 4,90,000.00 $ 11,162.64 6,60,000.00 4,94,061.92 $ 5,01,162.64 $ 4,90,000.00 4,90,000.00 4,061.92 $ 11,162.64 Less Amount to be invested Net Present Value

Key Issues

Office Expansion

Merits

1. This expansion will provide $125000 every year which provides Positive NPV as per the above calculation. Its better to use the office equipment for 6 years as it provides more NPV

Server Upgrade

Merits

1. This expansion will provide $165000 every year which provides Positive NPV as per the above calculation.

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