Question
In the Table below is information about two options that face the Alpha & Omega Company as it seeks to expand its operations. Note that
In the Table below is information about two options that face the Alpha & Omega Company as it seeks to expand its operations. Note that all cash flows are at the end of the year except for the initial costs.
| Option 1 | Option 2 |
Initial cost | $680,000 | $720,000 |
Usage life | 5 years | 6 years |
Salvage value at end of useful life | $20,000 | $30,000 |
Cash flows (excluding salvage value): |
|
|
Year 1 | $140,000 | $ 80,000 |
Year 2 | $140,000 | $180,000 |
Year 3 | $140,000 | $280,000 |
Year 4 | $140,000 | $380,000 |
Year 5 | $140,000 | $260,000 |
Year 6 | $ - | $150,000 |
Depreciation method is straight line |
|
|
Tax rate is | 20% | 20% |
Companys cost of capital | 12% | 12% |
Present value of $1.00
| Rate per period | |
Periods | 6% | 12% |
1 | 0.9434 | 0.8929 |
2 | 0.8900 | 0.7972 |
3 | 0.8396 | 0.7118 |
4 | 0.7921 | 0.6355 |
5 | 0.7473 | 0.5674 |
6 | 0.7050 | 0.5066 |
7 | 0.6651 | 0.4524 |
Present value of Ordinary Annuity of $1.00
| Rate per period | |
Periods | 6% | 12% |
1 | 0.9434 | 0.8929 |
2 | 1.8334 | 1.6900 |
3 | 2.6730 | 2.4018 |
4 | 3.4651 | 3.0373 |
5 | 4.2124 | 3.6048 |
6 | 4.9173 | 4.1114 |
7 | 5.5824 | 4.5638 |
1 Calculate the net present value for each option.
2 Calculate the payback period for each option
3. Based on the results in (a) and (b) what course of action would you recommend to the management of Alpha & Omega Company?
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