Question

1.       Choo Choo Inc. is a manufacturer of model trains. The company is considering the purchase of an industrial 3D printer, which will allow the firm to produce custom-made model trains for its high-end customers. The printer will cost $2,500,000, and it is expected to produce net cash flows of $600,000 per year for the next six years. Liquidation of the equipment will net the firm $350,000 in cash at the end of six years. The firm requires a 15% rate of return on all investments. Ignore the effects of taxes.                                                                                     (12 marks total)

a. What is the payback period for the proposed investment in the 3D printer? Provide your answer in number of years and months.                             (1 mark)

Answer

2,500,000/600,000

= 4.17 years. Accept the project since paybac\k is 4 years and under 2 months.

b. What is the printer’s discounted payback period? Provide your answer in number of years and months.                                                                    

Answer

Discounted payback period is the time by which discounted cashflow cover the

Initial investment outlay. This is not happening during project life hence it cannot be

calculated.

c.   Choo Choo’s cutoff period is set at five years. Based on the payback period investment criterion, will the company purchase the printer? Will it purchase the printer based on the discounted payback period investment criterion?                                                         (1 mark)

Answer

d. What is the printer’s net present value (NPV)? Should the company purchase the printer based on the NPV investment criterion?         (2.5 marks)

Answer

NPV = Cash inflow – cash outflow * (1-(1/1+rn)/r) + salvage value/(1+r)n – initial investment

       = 600000-0 *(1-(1/1+0.15)6/0.15) + 350000/(1+0.15)6 - 2500000

        = 600000 * 2.882183973 + 151314.6586 -2500000

        = 1880625.042 – 2500000

         = -619,374.9576. Hence, reject the project since NPV is negative.

e. What is the printer’s profitability index (PI)? Should the company purchase the printer based on the PI investment criterion?                            (1.5 marks)

Answer

Profitability index = Present value of future cash inflow/initial investment

                          = 600000-0 *(1-(1/1+0.15)6/0.15)+350000/(1+0.15)6/2500000

                          = 1880625.042/2500000

                           = 0.7523. Reject the project since the profitability index is less than 1.

                          

f.   What is the printer’s internal rate of return (IRR)?                            

Answer

g. Check that at the internal rate of return (IRR) the net present value of the printer is $0. Should the company purchase the printer based on the IRR investment criterion?                                        (1.5 marks)

h.       Based on your answers in parts a to f above, what decision do you recommend for Choo Choo?

Answer 1

Answer 1

a . Pay Back Period = 4.17 years

b. Discounted Payback Period cant be calculated as Cost couldn't be recovered within the life of assets.

c. If Critical Payback Period is 5 years, the project should be accepted as PBP is less than 5 years. However the as per the discounted payback period the project should be rejected as the cost couldnt be recovered during the life of machinery.

d. NPV = - $ 77,995.73. The project should be rejected as NPV is negative

e. PI = PVCI / PVCO = 0.969. The project should be rejected as PI is less than 1

f. IRR is 13.899 % or 14% appx.

g. Calculation of NPV at IRR is shown in Excel Sheet. The project should be rejected as IRR is less than Cost of Capital

h Since NPV is negative and IRR is less than Cost of Capital, The project should be rejected.