Question

Unequal lives-ANPV approach JBL Co. has designed a new conveyor system. Management must choose among three alternative courses of action: (1) The firm can sell the design outright to another corporation with payment over 2 years. (2) It can license the design to another manufacturer for a period of 5 ears, its 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 f capital of 12.5%. Cash flows associated with each alternative are as shown in the following table. (Click on the icon located on the top-right corner of the ata table below in order to copy its contents into a spreadsheet.) Alternative Initial investment (CFo) Year (t) Sell $199,100 License Manufacture $199,400 $451,000 Cash inflows (CFt) S250,800 100,400 79,300 $200,000 250,500 $200,800 245,000 200,800 . The net present value for the option to sell is $.(Round to the nearest cent.)

Answer 1

$NPV = - Initial Investment +\sum_{t=1}^{t} C_{t}/(1+r)^t$

a.

NPV of Option to sell,

NPV = $176,603.70

NPV of option to License,

NPV = $217,649.65

NPV of option to Manufacture,

NPV = $397,934.23

As per NPV values of different options, ranking options with higher NPV first,

1. Manufacture

2. License

3. Sell

b.

Annualized NPV,

Annualized NPV is calculated by taking,

PV = NPV

FV = 0

T = Time period of project

R = Cost of capital

PMT = Annualized NPV

Annualized NPV of option to sell = $105,183.09

Annualized NPV of option to License = $61,127.77

Annualized NPV of option to Manufacture = $98,162.32

Ranking according to Annualized NPV,

1. Sell

2. Manufacture

3. License

c.

Annualized NPV method is used to compare mutually exclusive projects which have unequal duration. It is preferred over NPV method because it adjusts its value according to the duration of the project to a comparable value across all project. With Annualized NPV one can compare projects with unequal duration in annualized form.