26-5A

The investment committee of Sentry Insurance Co. is evaluating two projects, office expansion and upgrade to computer servers. The projects have different useful lives, but each requires an investment of $490,000. The estimated net cash flows from each project are as follows:

Net Cash Flow

YearOffice Expansion Servers

1 125000 165000

2 125000 165000

3 125000 165000

4 125000 165000

5 125000

6 125000

The committee has selected a rate of 12% for purposes of net present value analysis. It also estimates that the residual value at the end of each projects useful life is $0, but at the end of the fourth year, the office expansions residual value would be $180,000.

1. For each project, compute the net present value. Use the present value of an annuity of $1 table appearing in this chapter (Exhibit 5). (Ignore the unequal lives of the projects.)

2. For each project, compute the net present value, assuming that the office expansion is adjusted to a four-year life for purposes of analysis. Use the present value of $1 table appearing in this chapter (Exhibit 2).

3. Prepare a report to the investment committee, providing your advice on the relative merits of the two projects.