   Chapter 26, Problem 26.21EX

Chapter
Section
Textbook Problem

Net present value—unequal lives Bunker Hill Mining Company has two competing proposals: a processing mill and an electric shovel. Both pieces of equipment have an initial investment of $750,000. The net cash flows estimated for the two proposals are as follows: Year Net Cash Flow Processing Mill Electric Shovel 1$310,000 $330,000 2 260,000 325,000 3 260,000 325,000 4 260,000 320,000 5 180,000 6 130,000 7 120,000 8 120,000 The estimated residual value of the processing mill at the end of Year 4 is$280,000. Determine which equipment should be favored, comparing the net present values of the two proposals and assuming a minimum rate of return of 15%. Use the present value table presented in this chapter (Exhibit 2).

To determine

Net present value method:

Net present value method is the method which is used to compare the initial cash outflow of investment with the present value of its cash inflows. In the net present value, the interest rate is determined by the business, based on the net income from the investment, and it is also called as the discounted cash flow method.

To determine: The more favorable equipment by comparing the net present value of both the proposals.

Explanation

Calculation of the Net Present Value of the Processing Mill is as follows:

 BHM Company Calculation of Net Present Value of Processing Mill Year Present Value of $1 at 15% (Exhibit 2) Net Cash Flow in$ Present Value of Net Cash Flow in $1 0.870 310,000$269,700 2 0.756 260,000 $196,560 3 0.658 260,000$171,080 4 0.572 260,000 $148,720 4 (residual value) 0.572 280,000$160,160 Total 1,370,000 $946,220 Less: amount to be invested$750,000 Net Present Value $196,220 Table (1) The calculation of net present value of Electric Shovel is as follows:  BHM Company Calculation of Net Present Value of Electric Shovel Year Present Value of$1 at 15% (Exhibit 2) Net Cash Flow in $Present Value of Net Cash Flow in$ 1 0...

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