The investment committee of Iron Skillet Restaurants Inc. is evaluating two restaurant sites. The sites have different useful lives, but each requires an investment of $1,000,000. The estimated net cash flows from each site are as follows:
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 $300,000.
Instruction
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.
SOLUTION:
Net present value analysis: