Contract Manufacturing, Inc., is considering two alternative investment proposals. The first proposal calls for a major...

Contract Manufacturing, Inc., is considering two alternative investment proposals. The first proposal calls for a major renovation of the company’s manufacturing facility. The second involves replacing just a few obsolete pieces of equipment in the facility. The company will choose one project or the other but not both. The cash flows associated with each project appear below and the firm discounts project cash flow at 15%:

Year: 0 ; 1 ; 2 ; 3 ; 4 ; 5

Renovate : -$9,000,000 ; 3,000,000 ; 3,000,000 ; 3,000,000 ; 3,000,000 ; 3,000,000

Replace: -$2,400,000 ; 200,000 ; 800,000 ; 200,000 ; 200,000 ; 200,000

Overall, You should find conflicting recommendations based on various criteria. Why is this occurring?

Expert Solution

Year	Renovate	Replace
0	-9000000	-2400000
1	3000000	200000
2	3000000	800000
3	3000000	200000
4	3000000	200000
5	3000000	200000

NPV	1056465.29	-1275882.78
IRR	19.86%	-13.76%

Select Renovate option since it has higher NPV. This is beneficial to the business. Also the IRR is greater than the cost of capital in this case.

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jeff jeffy answered 3 months ago

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