Question

The Titanic Shipbuilding Company has a noncancelable contract to build a small cargo vessel. Construction involves a cash outlay of $270,000 at the end of each of the next two years. At the end of the third year the company will receive payment of $620,000. Assume the IRR of this option exceeds the cost of capital. The company can speed up construction by working an extra shift. In this case there will be a cash outlay of $584,000 at the end of the first year followed by a cash payment of $620,000 at the end of the second year. Use the IRR rule to show the (approximate) range of opportunity costs of capital at which the company should work the extra shift. (Enter your answers as a percent rounded to 2 decimal places. Enter the smallest percent first.

Answer 1

Year	Projected schedule	Accelerated shift
1	-                       270,000	-                     584,000
2	-                       270,000	620,000
3	620,000

Using incremental analysis:

	C1	C2	C3
Current arrangement	-                       270,000	-                     270,000	620,000
Extra shift	-                       584,000	620,000
Incremental flows	-                       314,000	890,000	-    620,000

The IRRs for the incremental flows are (approximately) 23.30% and 60.14%.

If the cost of capital is between these rates then Titanic should work extra shift.