Reference no: EM132343828

Consider the following two mutually exclusive projects:

Year Cash Flow (A) Cash Flow (B)

0 -$364,000 -$52,000

1 46,000 25,000

2 68,000 22,000

3 68,000 21,500

4 458,000 17,500

Whichever project you choose, if any, you require a return of 11 percent on your investment.

1. If you apply the payback criterion, which investment will you choose? Why? (10%)

2. If you apply the NPV criterion, which investment will you choose? Why? (10%)

3. If you apply the IRR criterion, which investment will you choose? Why? (10%)

4. If you apply the profitability index criterion, which investment will you choose? Why? (10%)

5. Based on your answers in (1) through (4), which project will you finally choose? Why? (10%)

QUESTION 2:

The company is considering a new four-year expansion project that requires an initial investment in manufacturing machinery of $1,670,000. The machinery will be depreciated straight-line to zero over its four-year tax life (depreciation rate is 25% per year). At the end of the project, the machinery can be sold for 26% of its original cost. The project requires an initial investment in net working capital of $198,000; all of which will be recovered at the end of the project. The project is estimated to generate $1,850,000 in annual sales; with annual costs of $1,038,000. The tax rate is 21 percent and the required return for the project is 16.4%.

Instructions:

1. Calculate initial outlay (total cash flow in Year 0). (5%)

2. Calculate after-tax salvage value. (5%)

3. Complete the pro forma and determine total cash flows for each year of project's life. (25%)

4. Calculate the NPV of the project. (5%)

5. Calculate the IRR of the project. (5%)

6. Explain your decision whether you recommend to accept or reject the project. (5%)

Year

0

1

2

3

4

Sales

Costs

Depreciation

EBIT

Taxes

Net income

Operating Cash Flow

Capital spending

Net Working Capital

After-tax salvage value

Total cash flow