Question

FacebookFacebook is considering two proposals to overhaul its network infrastructure. They have received two bids. The first bid from Huawei will require a $25 million upfront investment and will generate $20 million in savings for FacebookFacebook each year for the next 3 years. The second bid from Cisco requires a $93 million upfront investment and will generate $60 million in savings each year for the next 3 years

A. What is the IRR for FacebookFacebook associated with each bid?

B. If the cost of capital for each investment is 10%, what is the net present value (NPV) for FacebookFacebook of each bid?

Suppose Cisco modifies its bid by offering a lease contract instead. Under the terms of the lease, FacebookFacebook will pay $27 million upfront, and $35 million per year for the next 3 years. FacebookFacebook's savings will be the same as with Cisco's original bid.

C. Including its savings, what are FacebookFacebook's net cash flow under the lease contract? What is the IRR of the Cisco bid now?

D. Is this new bid a better deal for FacebookFacebook than Cisco's original bid? Explain.

Answer 1

IRR

Huawei
IRR is the rate at which NPV =0	0
IRR	60.74%
Year	0	1	2	3
Cash flow stream	-25.000	20.000	20.000	20.000
Discounting factor	1.000	1.607	2.584	4.153
Discounted cash flows project	-25.000	12.443	7.741	4.816
NPV = Sum of discounted cash flows
NPV Huawei =	0.000
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	60.74%

Cisco
IRR is the rate at which NPV =0	0
IRR	41.97%
Year	0	1	2	3
Cash flow stream	-93.000	60.000	60.000	60.000
Discounting factor	1.000	1.420	2.016	2.861
Discounted cash flows project	-93.000	42.263	29.769	20.969
NPV = Sum of discounted cash flows
NPV Cisco =	0.000
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	41.97%

NPV

Huawei
Discount rate	10.000%
Year	0	1	2	3
Cash flow stream	-25	20	20	20
Discounting factor	1.000	1.100	1.210	1.331
Discounted cash flows project	-25.000	18.182	16.529	15.026
NPV = Sum of discounted cash flows
NPV Huawei =	24.74
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Cisco
Discount rate	10.000%
Year	0	1	2	3
Cash flow stream	-93	60	60	60
Discounting factor	1.000	1.100	1.210	1.331
Discounted cash flows project	-93.000	54.545	49.587	45.079
NPV = Sum of discounted cash flows
NPV Cisco =	56.21
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Cisco new bid

cash flows

Year	Cash flow stream
0	-27
1	25
2	25
3	25

Cisco
IRR is the rate at which NPV =0	0
IRR	75.45%
Year	0	1	2	3
Cash flow stream	-27.000	25.000	25.000	25.000
Discounting factor	1.000	1.754	3.078	5.401
Discounted cash flows project	-27.000	14.249	8.122	4.629
NPV = Sum of discounted cash flows
NPV Cisco =	0.000
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	75.45%

new bid is better as it has highest IRR