The investment committee of Mr. Bob Restaurants Inc. is evaluating two restaurant sites. The sites have different useful lives, but each requires an investment of $445,000. The estimated net cash flows from each site are as follows:
|
Net Cash Flows |
|
Year |
Site A |
Site B |
1 |
$170,000 |
$230,000 |
2 |
170,000 |
230,000 |
3 |
170,000 |
230,000 |
4 |
170,000 |
230,000 |
5 |
170,000 |
|
6 |
170,000 |
|
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, Site A’s residual value would be $340,000.
Instructions
1. For each site, compute the net present value. Use the present value of an annuity of $1 table appearing in this chapter. (Ignore the unequal lives of the projects.)
2. For each site, compute the net present value, assuming that Site A is adjusted to a four year life for purposes of analysis. Use the present value of $1 table appearing in this chapter.
3. Prepare a report to the investment committee, providing your advice on the relative merits of the two sites.