The investment committee of Auntie M's Restaurants Inc. is evaluating two restaurant sites. The sites have different useful lives, but each requires an investment of $900,000.
The estimated net cash flows from each site are as follows:
Net Cash Flows Year Wichita Topeka
1 $310,000 $400,000
2 310,000 400,000
3 310,000 400,000
4 310,000 400,000
5 310,000 6 310,000
The committee has selected a rate of 20% for purposes of net present value analysis. It also estimates that the residual value at the end of each restaurant's useful life is $0; but at the end of the fourth year, Wichita's residual value would be $500,000.
Present Value of $1 at Compound Interest Year 6% 10% 12% 15% 20%
1 0.943 0.909 0.893 0.870 0.833
2 0.890 0.826 0.797 0.756 0.694
3 0.840 0.751 0.712 0.658 0.579
4 0.792 0.683 0.636 0.572 0.482
5 0.747 0.621 0.567 0.497 0.402
6 0.705 0.564 0.507 0.432 0.335
7 0.665 0.513 0.452 0.376 0.279
8 0.627 0.467 0.404 0.327 0.233
9 0.592 0.424 0.361 0.284 0.194
10 0.558 0.386 0.322 0.247 0.162
Required:
1. For each site, compute the net present value. Use the The sum of the present values of a series of equal cash flows to be received at fixed intervals.present value of an annuity of $1 table above. Ignore the unequal lives of the projects. If required, round to the nearest dollar. Wichita Topeka Present value of annual net cash flows $ $ Less amount to be invested $ $ Net present value $ $
2. For each site, compute the net present value, assuming that Wichita is adjusted to a four-year life for purposes of analysis. Use the present value of $1 table above. If required, round to the nearest dollar. Wichita Topeka Present value of net cash flow total $ $ Less amount to be invested $ $ Net present value $ $
3. The net present value of the two sites over equal lives indicates that the Wichita Wichita Topeka site has a higher net present value and would be a superior investment.