Question

Dixie Dynamite Company is evaluating two methods of blowing up old buildings for commercial purposes over the next five years. Method one (implosion) is relatively low in risk for this business and will carry a 9 percent discount rate. Method two (explosion) is less expensive to perform but more dangerous and will call for a higher discount rate of 13 percent. Either method will require an initial capital outlay of $105,000. The inflows from projected business over the next five years are shown next.  
  

Years	Method 1			Method 2
1	$	33,000		$	18,900
2		30,500			28,300
3		42,000			40,700
4		37,500			34,300
5		20,700			70,400

Answer 1

Net Present Value (NPV) – METHOD 1

Year	Annual Cash Inflows ($)	Present Value factor at 9%	Present Value of Cash Inflow ($)
1	33,000	0.91743	30,275
2	30,500	0.84168	25,671
3	42,000	0.77218	32,432
4	37,500	0.70843	26,566
5	20,700	0.64993	13,454
TOTAL			1,28,398

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

= $1,28,398 - $105,000

= $23,398

Net Present Value (NPV) – METHOD 2

Year	Annual Cash Inflows ($)	Present Value factor at 13%	Present Value of Cash Inflow ($)
1	18,900	0.88496	16,726
2	28,300	0.78315	22,163
3	40,700	0.69305	28,207
4	34,300	0.61332	21,037
5	70,400	0.54276	38,210
TOTAL			1,26,343

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

= $1,26,343 - $105,000

= $21,343

DECISION

The Dixie Dynamite Company should select the Method one (implosion), since it has the highest Net Present Value (NPV) of $23,398 as compared to the NPV of Method 2.

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.