Question

Facebook is considering two proposals to overhaul its network infrastructure. They have received two bids. The first bid from Huawei will require a $ 23 million upfront investment and will generate $ 20 million in savings for Facebook each year for the next 33 years. The second bid from Cisco requires a $ 80 million upfront investment and will generate $ 60 million in savings each year for the next 33 years. a. What is the IRR for Facebook associated with each bid? b. If the cost of capital for each investment is 14 % 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 $ 27 million upfront, and $ 35 million per year for the next 33 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. a. What is the IRR for AOL associated with each bid? The IRR associated with the first bid from Huawei is nothing%. (Round to one decimal place.)

Answer 1

(a)	IRR -			BID 1	BID 2
				Huawei	Cisco
	Initial Investment			23	80
	Annual savings			20	60
	Life (Years)			33	33
	IRR is the rate at which Pv of inflow = Pv of outflow
	Here initial investment is done today so the pv = Initial Investment
	Let r be the rate =
	PVAF (r,33 ) x Annual savings = initial investment
	PVAR( r, 33) =		Initial Investment/ Annual Savings
	PVAR( r, 33) =			1.15	1.333333
				(23/20)	(80/60)
	Bid 1 -
	At r =			PVAF(r,33)
	85			1.1765
	r			1.1500
	90			1.1111
	Using linear Interpolation
	r- 85/90-85 =		1.15-1.1765/1.1111-1.1765
	r - 85 =		(-0.0265/0.0654) x 5
	r =		2.025 + 85
			87.025
	Bid 2 -
	At r =			PVAF(r,33)
	75			1.3333
	Therefore IRR =
	Bid 1 =			87.025
	Bid 2 =			75
(b)	IRR -			BID 1	BID 2
				Huawei	Cisco
	Initial Investment			23	80
	Annual savings			20	60
	Life (Years)			33	33
	PVAF(14%,33)			7.0482	7.0482
	PV of inflow (PVAF x Annual savings)			140.9646	422.8939
	Less; Initial investment			23	80
	NPV -			117.9646	342.8939
( c )	Net Annual cash flows =
	Annual Savings				60
	Annual Lease payments				35
					25
	Initial investment =				27
	PVAR( r, 33) =			27/25	1.08
	At r =			PVAF(r,33)
	90			1.1111
	r			1.0800
	95			1.0526
	Using linear Interpolation
	r-90/95 - 90 =		1.08-1.1111/1.0526-1.1111
	r- 90 =		(-0.0311/-0.0585) x 5
	r =		2.66 + 90
			92.66
			(Approx)
(d)	Yes it is better now as the IRR is higher then the original bid.
	Please provide feedback…. Thanks in advance…. :-)