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Project evaluation on the basis of NPV method

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Mountain Fresh Water Company is considering two mutually exclusive machines. Machine A has an up-front cost of $100,000 (CF0 = -100,000), and it produces positive after-tax cash inflows of $40,000 a year at the end of each of the next 6 years.

Machine B has an up-front cost of $50,000(CF0 = -50,000), and it produces after-tax cash inflows of $30,000 a year at the end of the next 3 years. After 3 years, Machine B can be replaced at a cost of $55,000 (paid at t = 3). The replacement machine will produce after-tax cash inflows of $32,000 a year for 3 years (inflows received at t = 4, 5, and 6).

The company's cost of capital is 10.5%. What is the net present value (on a 6-year extended basis) of the more profitable machine?

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Solution Summary

Solution describes the steps in comparing two mutually exclusive projects based on NPV method.

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Solution
Present Value = Future Value/(1+r/100)^n
Project : Machine A

Year End Cash Outflow Cash Inflow Net Cash Flow PV @ 10.5%
0 -100000 -100000 -100000
1 40000 40000 36199
2 40000 40000 32759
3 ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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