Question

The Pinkerton Publishing Company is considering two mutually exclusive expansion plans. Plan A calls for the expenditure of $50 million on a large-scale, integrated plant that will provide an expected cash flow stream of $8 million per year for 20 years. Plan B calls for the expenditure of $15 million to build a somewhat less efficient, more labor-intensive plant that has an expected cash flow stream of $3.4 million per year for 20 years. The firm's cost of capital is 10%.

a. Calculate each project's NPV and IRR.

b. Set up a Project ▵ by showing the cash flows that will exist if the firm goes with the large plant rather than the smaller plant. What are the NPV and the IRR for this Project ▵?

c. Graph the NPV profiles for Plan A, Plan B, and Project ▵.

Please show your work.

Answer 1

NPV is the excess of present value of all cash inflows over cash outflows.

NPV = PV of cash inflows - PV of cash outflows

IRR is the rate of return at which NPV=0

	Project A	Project B
Investment	$50 million	$15 million
Cash flows	$8 million	$3.4 million
Time	20 years	20 years
Discount rate	10%	10%