Problem:
Keller Construction is considering two new investments. Project E calls for the purchase of earth-moving equpitment. Project H represents an inverstment in a hydraulic lift. Keller wishes to use a net present value profile in comparing the projects. The investment and cash flow patterns are:
Project E Project H
($22,000 investment) ($20,000 investment)
Year Cash Flow Year Cash Flow
1 . . . . . . . . . . . . . .$ 5,000 1 . . . . . . . . . . . . . . .$16,000
2 . . . . . . . . . . . . . . .6,000 2 . . . . . . . . . . . . . . . . .5,000
3 . . . . . . . . . . . . . . .7,000 3 . . . . . . . . . . . . . . . . .4,000
4 . . . . . . . . . . . . . .10,000
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. Graph a net present value profile for the two investments similar to Figure 12-3. (Use a scale up to $8,000 on the vertical axis, with $2,000 increments. Use a scale up to 20 percent on the horizontal axis, with 5 percent increments.)
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? Use the net present value profile for your answer.