Question

Defense Electronics, Inc. (DEI), a large publicly traded firm is the market share leader in radar detection systems (RDSs), is considering a new project producing a new line of RDSs. The project will last 5 years and is expected to generate the following net cash flows (CFFA):

Year CFFA

1 $12,450,000

2 $12,450,000

3 $12,450,000

4 $12,450,000

5 $26,575,000

a) The initial cost of this project is $38,600,000. If the appropriate discount rate for this project is 12.31%, what is the NPV of this project?

b) What is the IRR on this project?

c) Do you recommend going ahead with this project? Why or why not? Clearly explain your answer.

Answer 1

a)	Year	CFFA	PVIF at 12.31%	PV at 12.31%
	0	$   -3,86,00,000	1	$      -3,86,00,000
	1	$     1,24,50,000	0.89039	$       1,10,85,389
	2	$     1,24,50,000	0.79280	$           98,70,349
	3	$     1,24,50,000	0.70590	$           87,88,486
	4	$     1,24,50,000	0.62853	$           78,25,204
	4	$     2,65,75,000	0.55964	$       1,48,72,403
	NPV of the project			$       1,38,41,830
b)	IRR is that discount rate for which NPV = 0. Such a discount rate is to be found out by trial
	and error.
	Year	CFFA	PVIF at 25%	PV at 25%	PV at 24%	PV at 24%
	0	$   -3,86,00,000	1	$      -3,86,00,000	1	$     -3,86,00,000
	1	$     1,24,50,000	0.80000	$           99,60,000	0.80645	$      1,00,40,323
	2	$     1,24,50,000	0.64000	$           79,68,000	0.65036	$          80,97,034
	3	$     1,24,50,000	0.51200	$           63,74,400	0.52449	$          65,29,866
	4	$     1,24,50,000	0.40960	$           50,99,520	0.42297	$          52,66,021
	4	$     2,65,75,000	0.32768	$           87,08,096	0.34111	$          90,64,938
				$            -4,89,984		$            3,98,183
	IRR lies between 24% and 25%. By simple interpolation IRR = 24%+1%*398183/(398183+489984) =							24.45%
c)	The firm can go ahead with the project as the NPV is positive.