Wachowicz Inc. is considering two average-risk alternative ways of producing its patented polo shirts. Process S has a cost of $8,000 and will produce net cash flows of $5,000 per year for 2 years. Process L will cost $11,500 and will produce cash flows of $4,000 per year for 4 years. The company has a contract that requires it to produce the shirts for 4 years, but the patent will expire after 4 years, so the shirts will not be produced after the 4th year. Inflation is expected to be zero during the next 4 years. If cash inflows occur at the end of each year, and if the cost of capital is 10%, by what amount will the better project increase the firm's value?
Solution contains calculations of net present value.