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12-18 Keller Construction: NPV profile comparing two new projects (investments)

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12-18. Keller Construction is considering two new investments. Project E calls for the purchase of earth-moving equipment. Project H represents an investment in a hydraulic lift. Keller wishes to use a net present value profile in comparing the projects. The investment and cash flow patterns are as follows:

Project E ($22,000 investment)
Year .............Cash Flow
1 . . . . . . . . $ 5,000
2 . . . . . . . . 6,000
3 . . . . . . . . 7,000
4 . . . . . . . . 10,000

Project H
($20,000 investment)
Year .............Cash Flow
1 . . . . . . . . $16,000
2 . . . . . . . . 5,000
3 . . . . . . . . 4,000

a. Determine the net present value of the projects based on a zero discount rate.

b. Determine the net present value of the projects based on a 9 percent discount rate.

c. The internal rate of return on Project E is 13.25 percent, and the internal rate of return on Project H is 16.30 percent.

d. If the two projects are not mutually exclusive, what would your acceptance or rejection decision be if the cost of capital (discount rate) is 8 percent?
(Use the net present value profile for your decision; no actual numbers are necessary.)

e. If the two projects are mutually exclusive (the selection of one precludes the selection of the other), what would be your decision if the cost of capital is (1) 6 percent, (2) 13 percent, (3) 18 percent? Once again, use the net present value profile for your answer.

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The solutions present the full calculations for the two investments together with explanations to aid understanding.

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a. Determine the net present value of the projects based on a zero discount rate.
b. Determine the net present value of the projects based on a 9 percent discount rate.

For a and b, please refer to the following table
Year Cash Flow Cash Flow
0 -22000 -20000
1 5000 16000
2 6000 5000
3 7000 4000
4 10000
Zero Discount PV 28000 25000
NPV 6000 5000
9% discount PV 22,126.77 21,976.03
NPV 126.77 1,976.03

c. The internal rate of return on Project E is 13.25 ...

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