Question

Cotter Manufacturing is considering investing in new technology which will reduce manufacturing costs in future years. There are three possible types of technology called BX124R or BX125R. Regardless of which technology is chosen (if chosen at all), the initial cost will be $3,500,000. The life of either technology is expected to be 5 years. The projected cost savings (cash flows) from BX124R are listed as follows: Year 1: $1,500,000; Year 2: $1,800,000; Year 3: $950,000; Year 4: $1,975,000; Year 5: $1,300,000. The projected cost savings (cash flows) from BX125R are listed as follows: Year 1: $900,000; Year 2: $600,000; Year 3: $570,000; Year 4: $1,075,000; Year 5: $3,000,000. Cotter’s cost of capital is 8%.

A) Calculate the NPV BX124R and BX125R.

B) Compute each the IRR for BX124R and BX125R.

C) Calculate the project’s payback period for BX124R and BX125R.

D) As the management accountant, would you recommend an investment in this technology (if the projects were independent)? What if the projects were mutually exclusive?

Answer 1

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Part A			a	b	a*b		c	a*c
		Period	PV @ 8%	BX124R	PV		BX125R	PV
Initial Cost		-	1.0000	$-3,500,000	$                -3,500,000		$-3,500,000	$-3,500,000
Cost Savings:
Year 1		1	0.9259	$ 1,500,000	$                 1,388,850		$     900,000	$     833,310
Year 2		2	0.8573	$ 1,800,000	$                 1,543,140		$     600,000	$     514,380
Year 3		3	0.7938	$     950,000	$                     754,110		$     570,000	$     452,466
Year 4		4	0.7350	$ 1,975,000	$                 1,451,625		$ 1,075,000	$     790,125
Year 5		5	0.6806	$ 1,300,000	$                     884,780		$ 3,000,000	$ 2,041,800
Net Present Value					$                 2,522,505			$ 1,132,081
Part B
		BX124R	BX125R
Initial Cost		$         -3,500,000	$                      -3,500,000
Year 1		$          1,500,000	$                           900,000
Year 2		$          1,800,000	$                           600,000
Year 3		$             950,000	$                           570,000
Year 4		$          1,975,000	$                        1,075,000
Year 5		$          1,300,000	$                        3,000,000
IRR		32.89%	17.05%
		IRR(Sum of cashflows)
Part C
		BX124R			BX125R
	Year	Cash Inflow	Cummulative Cash Inflow		Cash Inflow	Cummulative Cash Inflow
	1	$          1,500,000	$                        1,500,000		$                     900,000	$                           900,000
	2	$          1,800,000	$                        3,300,000		$                     600,000	$                        1,500,000
	3	$             950,000	$                        4,250,000		$                     570,000	$                        2,070,000
	4	$          1,975,000	$                        6,225,000		$                 1,075,000	$                        3,145,000
	5	$          1,300,000	$                        7,525,000		$                 3,000,000	$                        6,145,000
Payback Period	Years before Recovery	+	Unrecovered Cost at start of the year/Cash Flow during the Next year
	Years before Recovery	2			4
	Unrecovered Cost	3500000-3300000	$                           200,000			$                           355,000
	Cash Flow during year 3		$                           950,000			$                        3,000,000
Payback Period	2+(200000/950000)				4+(355000/3000000)
	2.21	Years			4.12	Years
Part D	yes
If Mutual Exculsive	BX124R is better as it has higher NPV and Lower PB Period