JBL Co. has designed a new conveyor system. Management must choose among three alternative courses of action: (1) The firm can sell the design outright to another corporation with payment over 2 years. (2) It can license the design to another manufacturer for a period of 5 years, its likely product life. (3) It can manufacture and market the system itself; this alternative will result in 6 years of cash inflows. The company has a cost of capital of 11.4%. Cash flows associated with each alternative are as shown in the following table. Alternative Sell License Manufacture Initial investment (CF0) $199,000 $200,600 $449,000 Year (t ) Cash inflows (CFt) 1 $199,500 $250,600 $200,300 2 250,400 100,700 255,000 3 — 79,700 200,300 4 — 59,700 200,300 5 — 40,500 200,300 6 — — 200,300 a. Calculate the net present value of each alternative and rank the alternatives on the basis of NPV. b. Calculate the annualized net present value (ANPV) of each alternative and rank them accordingly. c. Why is ANPV preferred over NPV when ranking projects with unequal lives?

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter10: Capital Budgeting: Decision Criteria And Real Option

Section10.A: Mutually Exclusive Investments Having Unequal Lives

Problem 2P

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JBL Co. has designed a new conveyor system. Management must choose among three alternative courses of action: (1) The firm can sell the design outright to another corporation with payment over 2 years. (2) It can license the design to another manufacturer for a period of 5 years, its likely product life. (3) It can manufacture and market the system itself; this alternative will result in 6 years of cash inflows. The company has a cost of capital of 11.4%.
Cash flows associated with each alternative are as shown in the following table.

Alternative	Sell	License	Manufacture
Initial investment (CF0)	$199,000	$200,600	$449,000
Year (t )	Cash inflows (CFt)
1	$199,500	$250,600	$200,300
2	250,400	100,700	255,000
3	—	79,700	200,300
4	—	59,700	200,300
5	—	40,500	200,300
6	—	—	200,300

a. Calculate the net present value of each alternative and rank the alternatives on the basis of NPV.

b. Calculate the annualized net present value (ANPV) of each alternative and rank them accordingly.

c. Why is ANPV preferred over NPV when ranking projects with unequal lives?

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