Question

Assignment Description: ABC Corporation has a machine that requires repairs or should be replaced. ABC has evaluated the two options and calculated the cash flows resulting from each option as follows: Option A: Repair the Machine Year Cash Flow 0 -50,000 1 15,500 2 20,100 3 18,900 4 17,100 5 13,700 Option B: Buy a new Machine Year Cash Flow 0 -400,000 1 51,300 2 155,000 3 127,800 4 126,900 5 125,100 You have recently been hired by ABC Corporation and your first assignment is to help them decide which of these two options should be pursued. You would like to apply Capital Budgeting and Time Value of Money concepts you have learnt in this class to analyze the problem and present your recommendation to your boss, Ms. Jane Austen. Conduct the analysis by calculating the Internal Rate of Return (IRR) and Net Present Value (NPV) for each option. The company has a Weighted Average Cost of Capital (WACC) of 12%. For this analysis, your boss asked you to calculate NPV at three different discount rates: 12% (the current WACC), 14% and 16%. Things to turn in: 1. A one-page memo explaining the results of your analysis and your recommendation. The memo should include important results of your analysis such as a summary table or graph. The memo is limited to one page so be very selective on what information to include. 2. An Excel spreadsheet showing calculation of Net Present Value at the 3 discount rates and calculation of Internal Rate of Return.

Answer 1

Hey there,

First of all have to tell you that, on our platform, we cant upload an excel sheet.

So I have taken the pictures of the excel sheet with utmost clarity.

The formula used are as follows

NPV "=NPV(rate,values)+initial outlay"

IRR "=IRR(values,guess)"

Hope the pictures are clear enough.

The decision rule for NPV says that Higher the NPV value, higher will the profitability.On the basis of NPV values we get, we will invest in option B when WACC is 12% as NPV value is coming out to be higher in option B,However @ 14 % and @ 12%, we would invest in Option A as they are showing us the higher values.

The decision rule for IRR says that select the project where WACC is lower than IRR.

Therefore, @ 12%,we can choose any of the projects as both the IRR values are lower than WACC, but Option B is more preferable.

@ 14% & 16%, we'll choose option A as the WACC values are lower than IRR.