Question

In: Finance

RainMan Inc. is in the business of producing rain upon request. The firm must decide between...

  1. RainMan Inc. is in the business of producing rain upon request. The firm must decide between two investment projects: a new airplane for seeding rain clouds or a new weather control machine built by Dr. Nutzbaum. The discount rate for the new airplane is 9%, while the discount rate for the weather machine is 39% (it happens to have higher market risk). If selected, the airplane or the weather machine would be repetitively replaced at the end of its useful life. The cash flows for one cycle for each project are as follows:

Year

Airplane

Weather Machine

0

–900

–900

1

500

550

2

600

600

3

685

  2. Which investment should the company select and why? There is no inflation.

a.

Airplane, because it has a higher equivalent annual cash flow.

b.

Weather machine, because it has a higher NPV.

c.

Airplane, because it has a higher NPV.

d.

Weather machine, because it has a higher equivalent annual cash flow.

Solutions

Expert Solution

Airplane
Discount rate 9.000%
Year 0 1 2
Cash flow stream -900 500 600
Discounting factor 1.000 1.090 1.188
Discounted cash flows project -900.000 458.716 505.008
NPV = Sum of discounted cash flows
NPV Airplane = 63.72
Where
Discounting factor = (1 + discount rate)^(Corresponding period in years)
Discounted Cashflow= Cash flow stream/discounting factor
Equvalent annuity(EAA)= 23.09
Required rate =   9.000%
Year 0 1 2
Cash flow stream 23.09 23.09 23.09
Discounting factor 1.000 1.090 1.188
Discounted cash flows project 23.094 21.188 19.438
Sum of discounted future cashflows = 63.72
Discounting factor = (1 + discount rate)^(Corresponding period in years)
Discounted Cashflow= Cash flow stream/discounting factor
Weather machine
Discount rate 39.000%
Year 0 1 2 3
Cash flow stream -900.000 550.000 600.000 685.000
Discounting factor 1.000 1.390 1.932 2.686
Discounted cash flows project -900.000 395.683 310.543 255.062
NPV = Sum of discounted cash flows
NPV Weather machine = 61.29
Where
Discounting factor = (1 + discount rate)^(Corresponding period in years)
Discounted Cashflow= Cash flow stream/discounting factor


Equvalent annuity(EAA)= 23.49
Required rate =   39.000%
Year 0 1 2 3
Cash flow stream 23.49 23.49 23.49 23.49
Discounting factor 1.000 1.390 1.932 2.686
Discounted cash flows project 23.489 16.898 12.157 8.746
Sum of discounted future cashflows = 61.29
Discounting factor = (1 + discount rate)^(Corresponding period in years)
Discounted Cashflow= Cash flow stream/discounting factor

Weather machine as it has higher equivalent annuity amount

jeff jeffy answered 1 year ago
Next > < Previous

Related Solutions

The manager of a regional warehouse must decide on the number of loading docks to request...
The manager of a regional warehouse must decide on the number of loading docks to request for a new facility in order to minimize the sum of dock costs and driver-truck costs. The manager has learned that each driver-truck combination represents a cost of $300 per day and that each dock plus loading crew represents a cost of $1,100 per day. How many docks should be requested if trucks arrive at the rate of three per day, each dock can...
For a firm to maximize profit, it must minimize the cost of producing whatever quantity it...
For a firm to maximize profit, it must minimize the cost of producing whatever quantity it produces. Use the isocost and isoquant tools to present a firm that is choosing the optimal levels of labor and capital (i.e., tools) to produce a certain quantity and a certain cost. Then, show in your diagram how this firm would respond if it were to expand and spend more on its inputs, assuming it is best for the firm to become more “capital...
When creating a business, the owners must decide on what taxable year to give the business....
When creating a business, the owners must decide on what taxable year to give the business. What choices of taxable years are available for "C" corporations, "S" corporations and partnerships? What impact does the choice of taxable year have on the taxation of the owners?
When creating a business, the owners must decide on what taxable year to give the business....
When creating a business, the owners must decide on what taxable year to give the business. What choices of taxable years are available for "C" corporations, "S" corporations and partnerships? What impact does the choice of taxable year have on the taxation of the owners?
Polytec Chemical, Inc. must decide between two additives to improve the dry-weather stability of its low-cost...
Polytec Chemical, Inc. must decide between two additives to improve the dry-weather stability of its low-cost acrylic paint. Additive A will have an equipment and installation cost of $106,000 and an annual cost of $55,000. Additive B will have an installation cost of $175,000 and an annual cost of $28,000. If the company uses a five-year recovery period for paint products and an MARR of 21% per year, which process is favored on the basis of an incremental rate of...
A firm must decide whether to make a component part in-house or to contract it out...
A firm must decide whether to make a component part in-house or to contract it out to an independent supplier. Manufacturing the part requires a nonrecoverable investment in specialized assets. The most efficient suppliers are located in countries with currencies that many foreign exchange analysts expect to appreciate substantially over the next decade. What are the pros and cons of (a) manufacturing the component in-house and (b) outsourcing manufacturing to an independent supplier? Which option would you recommend and why?...
Decide whether a booking must be made for the following business transactions and enter the account...
Decide whether a booking must be made for the following business transactions and enter the account name and amount. The sales tax (VAT) may have to be taken into account with 18%. If no booking record has to be formed, please make this clear with "No booking record". Info: Elektrovolt A.Ş., an industrial company, produces sockets and mainly supplies them to Cereyan A.Ş., a trading company. Unless otherwise stated, create the posting records for the following business transactions as of...
A firm plans to begin production of a new small appliance. The manager must decide whether...
A firm plans to begin production of a new small appliance. The manager must decide whether to purchase the motors for the appliance from a vendor for $7.30 each or to produce them in house. There are two in house options. Option 1 would have an annual fixed cost of $160000 and a variable cost of $5.30. Option 2 would have an annual fixed cost of $191000 and a variable cost of $3.90. Calculate the maximum quantity that would have...
A newly formed firm must decide on a plant location. There are two alternatives under consideration:...
A newly formed firm must decide on a plant location. There are two alternatives under consideration: locate near the major raw materials or locate near the major customers. Locating near the raw materials will result in lower fixed and variable costs than locating near the market, but the owners believe there would be a loss in sales volume because customers tend to favor local suppliers. Revenue per unit will be $175 in either case. Omaha Kansas City Annual fixed costs...
There are two firms, Cope and Peski, in an oligopolistic industry. Each firm must decide whether...
There are two firms, Cope and Peski, in an oligopolistic industry. Each firm must decide whether or not to advertise during the Super Bowl this year. The diagram below represents the matrix of expected profit payoffs for each firm depending on which of the four possible outcomes becomes reality. The first number in each cell represents the expected profit for Peski given the relevant combination of strategies for each firm. The second number in each cell represents the expected profit...
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT