Homework Answers
a) Present value is calculated as: [Cash Flow / (1 + Rtae of Interest)^Year]
| Year | A1 (Cash Flow) | Present value of A1 | A2 (Cash Flow) | Present value of A2 |
| 0 | -900 | -900.00 | -1,800 | -1,800.0 |
| 1 | -400 | -363.64 | -300 | -272.7 |
| 2 | -400 | -330.58 | -300 | -247.9 |
| 3 | -200 | -150.26 | -300 | -225.4 |
| 4 | -300 | -204.9 | ||
| 5 | -300 | -186.3 | ||
| 6 | -300 | -169.3 | ||
| 7 | -300 | -153.9 | ||
| 8 | 200 | 93.3 | ||
| -1,744.48 | -3,167.2 |
Alternative 1 should be selected as its present value is more than alternative 2.
b) If study period is only 3 years,
| Year | A1 | Present value of A1 | A2 | Present value of A2 |
| 0 | -900 | -900.00 | -1,800 | -1800.0 |
| 1 | -400 | -363.64 | -300 | -272.7 |
| 2 | -400 | -330.58 | -300 | -247.9 |
| 3 | -200 | -150.26 | -300 | -225.4 |
| -1744.48 | -2546.1 |
Present value of salvage is calculated as: [Salvage value / (1 + Rate of Interest)^Year]
Let salvage value be $X
Present value of salvage after 3 years = [X / (1 + 0.1)^3] = 0.751X
-2,546.1 + 0.751X = -1,744.48
X = 1,066.9 or 1,067
Salavge value of alternative 2 must be 1,067 to make these two alternative equally efficient.
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