Question

Problem Set 1 You are the owner of a large data-services firm and are deciding on the purchase of a new hardware cooling system that you expect will yield $233,300 in cost-savings per year for the next 15 years. The installation of this cooling system will cost $3,000,000.

1. At face value, does this system seem profitable? By how much?

2. Assume that your company uses a discount rate of 6%.

a. What is the Net Present Value (NPV) of this project?

b. How does the NPV of this project change as you assume a higher or lower discount rate? Why?

c. What is the IRR/ROI of this project?

d. How much should the yearly cost-savings be in order to break even? i. (hint) use goal-seek/what-if analysis

3. Suppose that you decide to finance the purchase of this system through a loan from the bank. The bank is willing to loan this money over an 8 year term at an interest rate of 4% per year.

a. Using a 70/30 debt-to-equity ratio, what is the NPV of this project? i. (hint) calculate the yearly payment using excel function “PMT”

b. How does the NPV of this project change if a larger portion is financed through equity (e.g. debt-to-equity ratio of 60/40)? Why?

Answer 1

You have asked a question with multiple parts and sub parts. I have addressed all the parts and sub parts up to Q - 2. Please post the balance questions separately.

Q - 1

Net profit / (loss) = Annual cost savings x number of years - initial investment = 233,300 x 15 - 3,000,000 = $ 499,500

Q - 2:

Please see the table below. The rows highlighted in yellow contain your answer. Figures in parenthesis, if any, mean negative values. All financials are in $. Adjacent cells in blue contain the formula in excel I have used to get the final output.

Part (a) NPV = - $ 734,132

Part (b) As discount rate increases, NPV decreases. NPV increases if discount rate decreases.

Part (c) IRR / ROI = 1.99%

Part (d) I have done goal seek in excel. Please see the table below:

the yearly cost-savings required in order to break even = $  308,888