1
3 0 6 - 3 1 0
E N G I N E E R I N G
E C O N O M Y
SOLUTIONS TO PROBLEM SET #6 – PROJECT EVALUATION CRITERIA
1.
The time distribution of cash flows associated with the project is as follows:
Time 0
:
-50 000
Years 1 to 15
:
20 000 - 8000 = 12 000
To determine whether the project is worthwhile economically, the net present value may be
computed, i.e., the annual cash flows are first discounted at a rate of 20 percent, the minimum
acceptable return on investment, and then summed algebraically.
NPV = -50 000 + 12 000 (P/A,20%,15)
= -50 000 + 12 000 (4.6755) = $6106
The net present value is positive.
Therefore, the project is worthwhile
.
2.
The cash flow profiles of the proposals are:
PROPOSAL 1
Year
Time 0
1
2
3
4
5
Cash Flow
($)
-1500
200
400
600
800
1000
PROPOSAL 2
Year
Time 0
1
2
3
4
5
Cash Flow
($)
-1 500
?
200
200
200
200
i)
The rate of return (r) is the discount rate at which the net present value is zero.
For pro-
posal 1, we have:
NPV = -1500 + [200 + 200 (A/G,r,5)] (P/A,r,5) = 0
Solving by trial and error (or with a financial calculator):
At r=21%, NPV=35.92
At r=22%, NPV=-5.77
By linear interpolation, the rate of return is:
21 + [35.92 / (35.92 + 5.77)] 1% = 21.9%
ii)
Given that the proposals are equally acceptable at a discount rate of 14%, their net present
values must be equal at that rate.

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