PE 26-5A Net present value—unequal lives

Project A requires an original investment of $22,500. The project will yield cash flows of $5,000 per year for nine years. Project B has a calculated net present value of $3,500 over a six-year life. Project A could be sold at the end of six years for a price of $12,000. (a) Determine the net present value of Project A over a six-year life, with residual value, assuming a minimum rate of return of 12%. (b) Which project provides the greatest net present value?

Answer:


a. Present value of $5,000 per year at 12% for 6 years*…………………………… $20,555 
Present value of $12,000 at 12% at the end of 6 years**………………………      6,084 
Total present value of Project A…………………………………………………… $26,639 
Less total cost of Project A…………………………………………………………   22,500 
Net present value of Project A……………………………………………………… $  4,139 
* [$5,000 × 4.111 (Exhibit 2, 12%, 6 years)] 
** [$12,000 × 0.507 (Exhibit 1, 12%, 6 years)] 
b. Project A. Project A’s net present value of $4,139 is more than the net present 
value of Project B, $3,500.