Question

Discount Rates, Quality, Market Share, Contemporary Manufacturing Environment

Sweeney Manufacturing has a plant where the equipment is essentially worn out. The equipment must be replaced, and Sweeney is considering two competing investment alternatives. The first alternative would replace the worn-out equipment with traditional production equipment; the second alternative uses contemporary technology and has computer-aided design and manufacturing capabilities. The investment and after-tax operating cash flows for each alternative are as follows:

Year	Traditional Equipment	Contemporary Technology
0	$(1,000,000)	$(4,000,000)
1	600,000	200,000
2	400,000	400,000
3	200,000	600,000
4	200,000	800,000
5	200,000	800,000
6	200,000	800,000
7	200,000	1,000,000
8	200,000	2,000,000
9	200,000	2,000,000
10	200,000	2,000,000

The company uses a discount rate of 18 percent for all of its investments. The company's cost of capital is 14 percent.

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

Required:

1. Calculate the net present value for each investment using a discount rate of 18 percent. Round intermediate calculations and the final answers to the nearest dollar. If the NPV is negative, enter your answer as a negative value.

	NPV
Traditional equipment	$_______
Contemporary technology	$_______

2. Calculate the net present value for each investment using a discount rate of 14 percent. Round intermediate calculations and the final answers to the nearest dollar.

	NPV
Traditional equipment	$________
Contemporary technology	$________

3. Which rate should the company use to compute the net present value?
The 14% cost of capital

4. Now, assume that if the traditional equipment is purchased, the competitive position of the firm will deteriorate because of lower quality (relative to competitors who did automate). Marketing estimates that the loss in market share will decrease the projected net cash inflows by 50 percent for Years 3–10. Recalculate the NPV of the traditional equipment given this outcome using a discount rate of 14 percent. Round intermediate calculations and your final answer to the nearest dollar.

What is the NPV now?

$________________

Answer 1

SOLUTION TO Q1 TRADITIONAL EQUIPMENT						CONTEMPORARY TECHNOLOGY
When the discount rate is 18%						When the discount rate is 18%
YEAR	CASH FLOW	@ 18%	cash inflow in $			YEAR	CASH FLOW	@ 18%	cash inflow in $
1	600000	0.847457627	508475			1	200000	0.847458	169492
2	400000	0.71818443	287274			2	400000	0.718184	287274
3	200000	0.608630873	121726			3	600000	0.608631	365179
4	200000	0.515788875	103158			4	800000	0.515789	412631
5	200000	0.437109216	87422			5	800000	0.437109	349687
6	200000	0.370431539	74086			6	800000	0.370432	296345
7	200000	0.313925033	62785			7	1000000	0.313925	313925
8	200000	0.266038164	53208			8	2000000	0.266038	532076
9	200000	0.225456071	45091			9	2000000	0.225456	450912
10	200000	0.191064467	38213			10	2000000	0.191064	382129
	TOTAL CASH INFLOW		1381438				TOTAL CASH INFLOW		3559650
	CASH OUTFLOW		1000000				CASH OUTFLOW		4000000
	NPV(in dollars)		381438				NPV(in dollars)		-440350	(negative cash inflow)
	(NPV=Cash inflow- cash outflow)						(NPV=Cash inflow- cash outflow)

SOLUTION TO QUESTION 2
TRADITIONAL EQUIPMENT						CONTEMPORARY TECHNOLOGY
When the discount rate is 14%						When the discount rate is 14%
YEAR	CASH FLOW	@ 14%	cash inflow in $			YEAR	CASH FLOW	@ 14%	cash inflow in $
1	600000	0.877192982	526316			1	200000	0.877193	175439
2	400000	0.769467528	307787			2	400000	0.769468	307787
3	200000	0.674971516	134994			3	600000	0.674972	404983
4	200000	0.592080277	118416			4	800000	0.59208	473664
5	200000	0.519368664	103874			5	800000	0.519369	415495
6	200000	0.455586548	91117			6	800000	0.455587	364469
7	200000	0.399637323	79927			7	1000000	0.399637	399637
8	200000	0.350559055	70112			8	2000000	0.350559	701118
9	200000	0.307507943	61502			9	2000000	0.307508	615016
10	200000	0.26974381	53949			10	2000000	0.269744	539488
	TOTAL CASH INFLOW		1547994				TOTAL CASH INFLOW		4397096
	CASH OUTFLOW		1000000				CASH OUTFLOW		4000000
	NPV(in dollars)		547994				NPV(in dollars)		397096
	(NPV=Cash inflow- cash outflow)						(NPV=Cash inflow- cash outflow)

QUESTION NO 3
Thus a discount rate of 14% should be opted for QUESTION NO 4 THE PROJECTED CASH FLOW DECREASES BY 50%,SINCE TRADITIONAL EQUPMENT IS PURCHASED YEAR CASH FLOWS @ 14% cash inflow in $ 1 600000 0.877192982 526316 2 400000 0.769467528 307787 3 100000 0.674971516 67497 4 100000 0.592080277 59208 5 100000 0.519368664 51937 6 100000 0.455586548 45559 7 100000 0.399637323 39964 8 100000 0.350559055 35056 9 100000 0.307507943 30751 10 100000 0.26974381 26974 TOTAL CASH INFLOW 1191049 CASH OUTFLOW 1000000 NPV(in dollars) 191049 (NPV=Cash inflow- cash outflow) (Note:the cash flow from year 3-10 is taken as exactly half of the projected cash flow)