Question

PLEASE COMPLETE IN EXCEL

1.        Davis Industries must choose between a gas-powered and an electric-powered forklift truck for moving materials in its factory. Because both forklifts perform the same function, the firm will choose only one. (They are mutually exclusive investments.) The electric-powered truck will cost more, but it will be less expensive to operate, it will cost $23,000, whereas the gas-powered truck will cost $14,500. The cost of capital that applies to both investments is 13%. The life cycle for both types of truck is estimated to be 6 years, during which time the net cash flows for the electric-powered truck will be $6,200 per year and those for the gas-powered truck will be $3,500 per year. Annual net cash flows include depreciation expenses. Calculate the NPV and IRR for each type of truck and decide which to recommend.
2.        After discovering a new gold vein in the Colorado Mountains, CTC Mining Corp must decide whether to go ahead and develop the deposit. The most cost-effective method of mining gold is sulfuric acid extraction, a process that could result in environmental damage. Before proceeding with the extraction, CTC must spend $900,500 for new mining equipment and pay $250,000 for its installation. The gold mined will net the firm an estimated $345,000 each year for the 5-year life of the vein. CTC’s cost of capital is 14%. For the purposes of this problem, assume that the cash inflows occur at the end of the year.

1.        What are the project’s NPV and IRR?
2.       Should this project be undertaken if environmental impacts were not a consideration?
3.        How should environmental effects be considered, or any other, project?

Answer 1

1.

Let Cash Flow in year n be CFn

Hence, NPV = ΣCFn*PV Factor, where PV Factor = 1/(1+r)ⁿ

Given, cost of capital = r = 13%

Calculating using excel formula "=NPV(rate, values)" for NPV and "=IRR" for IRR

Year	CF Gas	CF Electric
0	-14500	-23000
1	3500	6200
2	3500	6200
3	3500	6200
4	3500	6200
5	3500	6200
6	3500	6200
NPV	-450.07	1579.48
IRR	11.73%	15.75%

Since the NPV of Electric truck if +ve, it should be selected

2.

Cash Flow in period 0 = 900500 + 250000 = $1150500

Cash FLow from period 1 to 5 = $345000

Using NPV and IRR formula with cost of capital = 14%,

Year	CF
0	-1150500
1	345000
2	345000
3	345000
4	345000
5	345000
NPV	29748.19
IRR	15.22%

Hence, NPV = $29748.19 and IRR = 15.22%

The project should be undertaken (since NPV >0) if environmental effects are not taken into account

If environmental effects are taken into account, the Cash flow for each period should be reduced by the cost of environmental effect and then NPV should be computed again