Question

Gina Ripley, president of Dearing Company, is considering the purchase of a computer-aided manufacturing system. The annual net cash benefits and savings associated with the system are described as follows:

Decreased waste	$300,000
Increased quality	400,000
Decrease in operating costs	600,000
Increase in on-time deliveries	200,000

The system will cost $9,000,000 and last 10 years. The company’s cost of capital is 12 percent.

The present value tables provided in Exhibit 19B.1 and Exhibit 19B.2 must be used to solve the following problems.

Required:

1. Calculate the payback period for the system.
years

Assume that the company has a policy of only accepting projects with a payback of five years or less. Would the system be acquired?
No

2. Calculate the NPV and IRR for the project. Round your IRR answers to the nearest whole percentage value (for example, 15.6% rounds to 16% and should be entered as "16" in the answer box). If the NPV is negative, enter your answer as a negative value.

NPV:	$
IRR:	Between	%	and		%

Should the system be purchased—even if it does not meet the payback criterion?
Yes

3. The project manager reviewed the projected cash flows and pointed out that two items had been missed. First, the system would have a salvage value, net of any tax effects, of $1,000,000 at the end of 10 years. Second, the increased quality and delivery performance would allow the company to increase its market share by 20 percent. This would produce an additional annual net benefit of $300,000. Recalculate the payback period, NPV, and IRR given this new information. (For the IRR computation, initially ignore salvage value.) Round your IRR answers to the nearest whole percentage value (for example, 15.6% rounds to 16% and should be entered as "16" in the answer box). If the NPV is negative, enter your answer as a negative value.

Payback period:		years
NPV:	$
IRR:	Between	%	and		%

Does the decision change?
Yes

Suppose that the salvage value is only half what is projected. Does this make a difference in the outcome? Does the salvage value have any real bearing on the company's decision?
No - in this case the decrease in salvage value is not enough to change the decision

Answer 1

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1. Payback Period
Investment	a	$                         9,000,000
Annual Net cash Flow	b	$                         1,500,000
Payback Period	a/b	6	Years
NO
2. NPV
Year	Cash Flow	Discount Factor 12%,n=10	PV
-	$-9,000,000	1.000	$ -9,000,000
1-10	$ 1,500,000	5.650	$ 8,475,000
Net Present Value			$    -525,000
IRR:
Period		10 Years
Discount Factor ($9,000,000/$1,500,000)		6.00
Searching table for 10 Year, 6%		10.56%
Hence IRR will be between 10 and 11%
NO
Part 3
a. Payback Period
Investment	a	$                         9,000,000
Annual Net cash Flow	b	$                         1,800,000
Payback Period	a/b	5	Years
b. NPV
Year	Cash Flow	Discount Factor 12%,n=10	PV
-	$-9,000,000	1.000	$ -9,000,000
1-10	$ 1,800,000	5.650	$10,170,000
10	$ 1,000,000	0.322	$     322,000
Net Present Value			$ 1,492,000
IRR:
Period		10 Years
Discount Factor ($9,000,000/$1,500,000)		6.00
Searching table for 10 Year, 6%		10.56%
Hence IRR will be between 15 and 16%	16%
Yes
NO