Question

-Financial Management Principles

German Technologies Inc. operates a small chain of speciallity retail stores throughout the U.S. southwest. The conpamy markets technology-based consumer products both in its stores and over the internet, with sales split roughly equally between the two channel distribution. The company’s products range from radar detection devices and GPS mapping systems used in automobiles to home-based weather monitoring stations. The company recently began investigating the possible acquisition of a regional wearhousing faciltiy that could be used to stock its retail shops and to make direct shipments to the firms online consumer’s. the wearhouse facility would require an expenditure of $250,000 for a rented space in Oklahoma City,Oklahoma, and would provide source of cash flow spanning the next 10 years. The estimated cash flows are as follows:

Year Cash flow

0 $(250,000)

1 60,000

2 60,000

3 60,000

4 60,000

5 (45,000)

6 65,000

7 65,000

8 65,000

9 65,000

10 90,000

The negative cash flow in Year 5 reflects the cost of a planned renovation and expansion of the facility. Finally, in Year 10 German estimates some recovery of its investment at the close of the lease, and consequently a higher-than-usual cash flow. German uses a 12 percent discount rate in evaluating its Investments.

a. As a preliminary step in analyzing the new investment, German’s management has decided to evaluate the project’s anticipated payback period. What is the project’s expected payback period? Jim German, CEO, questioned the analyst performing the analysis about the meaning of the payback period. Specifically, he wanted to know what useful information the payback period provides. If you were the analyst, how would you respond to Mr. German? And would you recommend using the payback period as a decision criterion? Explain your answer.

b. The lead financial analyst on the project suggested that there may be a problem with IRR because the sign on the cash flows changes three times over its life. Evaluate the NPV profile of the project for discount rates of 0 percent, 20 percent, 50 percent, and 100 percent. Does there appear to be a problem of multiple IRR in this range of discount rates?

c. Calculate the internal rate of return for the project. What does this measure tell you about the projects viability?

d. Calculate the project’s NPV. What does the NPV indicate about the potential value created by the project? Describe to Mr. German what NPV means, recognizing that he was trained as an engineer and has no formal business education.

Answer 1

(C) since irr of the project is greater than discount rate then Mr. German should slect th project.

(D) the NPV of the project is positive or greater than one. This implies that the wealth increases by investing in the project. Mr. German should accept the project definitely.