Question

The Titanic Shipbuilding Company has a noncancelable contract to build a small cargo vessel. Construction involves a cash outlay of $271,000 at the end of each of the next two years. At the end of the third year the company will receive payment of $640,000. Assume the IRR of this option exceeds the cost of capital.

The company can speed up construction by working an extra shift. In this case, there will be a cash outlay of $592,000 at the end of the first year, followed by a cash payment of $640,000 at the end of the second year. Use the IRR rule to show the (approximate) range of opportunity costs of capital at which the company should work the extra shift. (Enter your answers as a percent rounded to 2 decimal places. Enter the smallest percent first.)

The company should work the extra shift if the cost of capital is between % and %

Answer 1

		Year	Cash Flow
		0	$0
		1	($271,000)
		2	($271,000)
		3	$640,000
			11.61%	(Using IRR function of excel over the cash flow)
		IRR	11.61%
		Present Value of Cash Flow=(Cash Flow)/((1+i)^N)
		i=discount rate, N=Year of cash flow
		Working an extra Shift
		Year	Cash Flow	PV at 0%	PV at 5%	PV at 8.11%	PV at 10%
		0	$0	$0	$0	$0	$0
		1	($592,000)	($592,000)	($563,810)	($547,590)	($538,182)
		2	$640,000	$640,000	$580,499	$547,581	$528,926
			NPV	$48,000	$16,689	($10)	($9,256)
	IRR	8.1081%	(Using IRR function of excel over the cash flow)
		Company should work the extra shift if the cost of capital is between 0% and 8.10%