Payback period and irr, Financial Management

To look into the feasibility of a new production system, K-Pad, the largest P.C. producer in the region, has spent $88,000 on the technical feasibility study. In view of the favorable comment of the study, K-Pad is considering replacing one of its production system with either of two new production systems - system A or system B. System A is a highly automated, computer-controlled system that uses cutting edge technology; system B is a less expensive system that uses standard technology. To analyze these alternatives, Janice Yan, a financial analyst, prepared estimates of the initial investment and cash inflows associated with each system. These are shown in the following table.


System A

System B

Initial investment

$660,000

$360,000

Year

Cash inflows

1

$128,000

$88,000

2

$182,000

$120,000

3

$166,000

$96,000

4

$168,000

$86,000

5

$450,000

$207,000

Note that Janice plans to analyze both systems over a 5-year period. At the end of that time, the systems would be sold, thus accounting for the large fifth-year cash inflows. Janice believes that the two systems are equally risky and that the acceptance of either of them will not change the firm's overall risk. She therefore decides to apply the firm's 13% cost of capital when analyzing the systems. K-Pad requires all projects to have a maximum payback period of 4.0 years.

Required:

(a) Use the payback period to determine which system should be chosen.               

(b) Use both NPV and IRR to rank each system.                                                                

(c) Summarize the preferences indicated by the techniques used in parts (a) and (b). Which system should be chosen? Why?                                                                                      

(d) Draw the net present value profiles for both systems on the same set of axes, and discuss any conflict in rankings that may exist between NPV and IRR. Explain any observed conflict in terms of the relative differences in the magnitude and timing of each system's cash flows

(e) Use your findings in parts (a) through (b) to indicate, on both a theoretical basis and a practical basis, which system would be preferred. Explain any difference in recommendations.

Posted Date: 2/23/2013 5:01:24 AM | Location : United States







Related Discussions:- Payback period and irr, Assignment Help, Ask Question on Payback period and irr, Get Answer, Expert's Help, Payback period and irr Discussions

Write discussion on Payback period and irr
Your posts are moderated
Related Questions
Case Study based on Financial Statement Analysis of Hatsun Agro Private Limited 800x600 Normal 0 false false false EN-IN X-NONE X-NONE

Q. Show External business risk? External risk is the result of operating conditions imposed on the firm by circumstances beyond its control. The external environments in which

Disclosure requirements · Common information about how operating segments were identified and types of products and services from which every operating segment derives its rev

Q. What do you mean by Cash Flow Ratios? Cash Flow Ratios: - Cash Flow Ratios are an additional device of cash management. Some important cash flow ratios are: (i) Cash Turn

What is the potential of having agency problems


Definition of 'Beta' A measure of the volatility or systematic risk of a security or a portfolio in difference to the market as a whole. Beta is needed in the capital asset pri

Peak Inc. needs to order Canadian raw materials to use in its production process. The Canadian exporter typically invoices Peak in Canadian dollars. Assume that the current exchang

Contractual savings institutions Contractual savings institutions obtain funds at periodic intervals on a contractual basis. The industry is classified into two main groups ins

Relationship between Bond Price and Time   (If Interest Rates are Constant) The bond price changes as the bond moves closer to its maturity. If the bond is quoted