Reference no: EM132413518
MBATech, Inc., is negotiating with the mayor of Bean City to start a manufacturing plant in an abandoned building.
The cash flows for MBAT's proposed plant are:
Year 0: -1,000,000
Year 1: 371,739
Year 2: 371,739
Year 3: 371,739
Year 4: 371,739
The city has agreed to subsidize MBAT. The form and timing of the subsidy have not been determined, and depend on which investment criterion is used by MBAT. In preliminary discussions, MBAT suggested four alternatives:
[A] Subsidize the project to bring its IRR to 25%.
[B] Subsidize the project to provide a two-year payback.
[C] Subsidize the project to provide an NPV of $75,000 when cash flows are discounted at 20%.
[D] Subsidize the project to provide an accounting rate of return (ARR) of 40%. This is defined as:
Equation
ARR= (Average Annual Cash Flow - [Investment/# of Years])/(Investment/2)
You have been hired by Bean City to recommend a subsidy that minimizes the costs to the city. Subsidy payments need not occur right away; they may be scheduled in later years if appropriate. Please indicate how much of a subsidy you would recommend for each year under each alternative suggested by MBAT.
Which of the four subsidy plans would you recommend to the city if the appropriate discount rate is 20%?
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