Question

(Show work, please!)

A business is evaluating two alternative, mutually exclusive methods for a deli bar to be added to their stores. It has developed the following estimated after- tax cost savings for each alternative method. The project discount, and reinvestment, rate is 11%.

	To	T1	T2	T3
A: Staffed Deli	(35,500)	23,000	26,200	31,200
B: Self Serve Deli	(27,500)	19,700	21,300	23,500

a. Which method (staffed or self serve) would you recommend using an NPV approach?

b. Which method would you recommend using the MIRR #3 Approach?

c. Which method do you recommend? Explain fully.

Answer 1

	a)
		NPV Approach
		Year	Discount Factor @11%	Staffed Deli		Self Serve Deli
				Cash Flow	Discounted Cash Flow	Cash Flow	Discounted Cash Flow
		a	b	c	d=c*b	e	f=e*b
		0	1.000	-35500	-35500.00	-27500.00	-27500.00
		1	0.901	23000	20720.72	19700.00	17747.75
		2	0.812	26200	21264.51	21300.00	17287.56
		3	0.731	31200	22813.17	23500.00	17183.00
			NPV		29298.40		24718.30
		Since NPV of Staffed Deli is more than self-service, the staffed deli approach preferable.
	b)	Calculation Of IMRR
		IMRR is the discount rate at which the present value of cash outflow is equal to the present value of the terminal value of cash inflow.
			TV = Terminal Value
			TV = FV1 + FV2 + FV3
			= PV(1+k)^n + PV2 (1+k)^n2 + PV3 (1+k)^n3
		For Staffed Deli
			=23000(1.11)^2+26200(1.11)^1+31200(1.11)^0
			=88620.3
			35500 = 88620.3/(1+r)^3
			(1+r)^3 = 86620/35500
			(1+r)^3 =2.44
			1+r = 1.5620
			r = .5620
			r=56.20%
		Therefore IMRR =56.20%
		For Self Serve Deli
			=19700(1.11)^2+21300(1.11)^1+23500(1.11)^0
			TV = 71415.37
			27500 = 71415.37/(1+r)^n
			27500=71415.37(1+r)^3
			(1+r)^3 = 71415.37/27500
			(1+r)^3 = 2.5969
			1+r =1.611
			r =61.1%
		IMRR =61.11%
	Self-service method would be beneficial in terms of IMRR
	c)	NPV provides a more realistic approach hence I will recommend for NPV method