Question

Facebook is considering two proposals to overhaul its network infrastructure. They have received two bids. The first bid from Huawei will require a $ 20 million upfront investment and will generate $ 20 million in savings for Facebook each year for the next 3 years. The second bid from Cisco requires a $ 101 million upfront investment and will generate $ 60 million in savings each year for the next 3 years. a. What is the IRR for Facebook associated with each? bid? b. If the cost of capital for each investment is 10 %?, what is the net present value ?(NPV?) for Facebook of each? bid? Suppose Cisco modifies its bid by offering a lease contract instead. Under the terms of the? lease, Facebook will pay $ 24 million? upfront, and $ 35 million per year for the next 3 years.? Facebook's savings will be the same as with? Cisco's original bid. c. Including its? savings, what are? Facebook's net cash flow under the lease? contract? What is the IRR of the Cisco bid? now? d. Is this new bid a better deal for Facebook than? Cisco's original? bid? Explain.

Answer 1

(a)	IRR of Huawei
	Pv of cash inflow = PV of cash outflow
	20 x PVAF(r,3) =		20
	PVAF(r,3) =		1
	Using hit and trial -
	PVAF(84%,3)=		1
	IRR of Huawei		84%
			Approx
	IRR of Cisco -
	Pv of cash inflow = PV of cash outflow
	60 x PVAF(r,3) =		101
	PVAF(r,3) =		1.683333
	Using linear Interpolation -
	r =		PVAF(r,3)
	36%		1.67349
	r		1.68333
	37%		1.65162
	r-36/37-36 =		1.6833-1.6724/1.65162-1.6724
	r-36 =		-0.44985
	r=		35.55015
	IRR of Cisco -		35.55015
(b)	Year	Huawei CF	Cisco CF	PV factor @ 10%	PV of CF(Huawei)	PV of CF(Cisco)
	0	-20	-101	1	-20	-101
	1	20	60	0.909091	18.18182	54.54545
	2	20	60	0.826446	16.52893	49.58678
	3	20	60	0.751315	15.0263	45.07889
		NPV =			29.73704	48.21112
(c )	Year	Outflow	Savings	NET Cash flows
	0	-24	0	-24
	1	-35	60	25
	2	-35	60	25
	3	-35	60	25
	IRR of new bid from cisco =
	Pv of cash inflow = PV of cash outflow
	25 x PVAF(r,3) =		24
	PVAF(r,3) =		0.9600
	Using linear Interpolation -
	r =		PVAF(r,3)
	88%		0.96534
	r		0.96000
	89%		0.95717
	r-88/89-88 =		0.96-0.96534/0.95717-0.96534
	r-88=		0.653673
	r=		88.65367
	IRR of new bid from cisco =		88.65367
(d)	Yes the new bid provides higher reurn then the original bid of cisco.