Question

Discount Rates, Quality, Market Share, Contemporary Manufacturing Environment

Sweeney Manufacturing has a plant where the equipment is essentially worn out. The equipment must be replaced, and Sweeney is considering two competing investment alternatives. The first alternative would replace the worn-out equipment with traditional production equipment; the second alternative uses contemporary technology and has computer-aided design and manufacturing capabilities. The investment and after-tax operating cash flows for each alternative are as follows:

Year	Traditional Equipment	Contemporary Technology
0	$(990,100)	$(4,002,950)
1	596,250	206,400
2	396,750	399,350
3	203,900	603,300
4	203,900	807,100
5	203,900	807,100
6	203,900	807,100
7	203,900	990,800
8	203,900	1,991,550
9	203,900	1,991,550
10	203,900	1,991,550

The company uses a discount rate of 18 percent for all of its investments. The company's cost of capital is 14 percent.

The present value tables provided in Exhibit 19B.1 and Exhibit 19B.2 must be used to solve the following problems.

Required:

1. Calculate the net present value for each investment using a discount rate of 18 percent. Round intermediate calculations and the final answers to the nearest dollar. If the NPV is negative, enter your answer as a negative value.

	NPV
Traditional equipment	$
Contemporary technology	$

2. Calculate the net present value for each investment using a discount rate of 14 percent. Round intermediate calculations and the final answers to the nearest dollar.

	NPV
Traditional equipment	$
Contemporary technology	$

3. Which rate should the company use to compute the net present value?
The 14% cost of capital

4. Now, assume that if the traditional equipment is purchased, the competitive position of the firm will deteriorate because of lower quality (relative to competitors who did automate). Marketing estimates that the loss in market share will decrease the projected net cash inflows by 50 percent for Years 3–10. Recalculate the NPV of the traditional equipment given this outcome using a discount rate of 14 percent. Round intermediate calculations and your final answer to the nearest dollar.

What is the NPV now?
$

What is the decision now?
Contemporary technology is preferred

Answer 1

1.

Traditional Equipment
Year	Cash Flow (C)	PV Factor @ 18 %(F)	PV (=C x F)
0	($990,100)	1	($990,100)
1	$596,250	0.8475	$505,322
2	$396,750	0.7182	$284,946
3	$203,900	0.6086	$124,094
4	$203,900	0.5158	$105,172
5	$203,900	0.4371	$89,125
6	$203,900	0.3704	$75,525
7	$203,900	0.3139	$64,004
8	$203,900	0.266	$54,237
9	$203,900	0.2255	$45,979
10	$203,900	0.1911	$38,965
		NPV	$397,268

Contemporary Technology
Year	Cash Flow (C)	PV Factor @ 18 %(F)	PV (=C x F)
0	($4,002,950)	1	($4,002,950)
1	$206,400	0.8475	$174,924
2	$399,350	0.7182	$286,813
3	$603,300	0.6086	$367,168
4	$807,100	0.5158	$416,302
5	$807,100	0.4371	$352,783
6	$807,100	0.3704	$298,950
7	$990,800	0.3139	$311,012
8	$1,991,550	0.266	$529,752
9	$1,991,550	0.2255	$449,095
10	$1,991,550	0.1911	$380,585
		NPV	($435,565)

	NPV
Traditional Equipment	$397,268
Contemporary Technology	-$435,565

2.

Traditional Equipment
Year	Cash Flow (C)	PV Factor @ 14 %(F)	PV (=C x F)
0	($990,100)	1	($990,100)
1	$596,250	0.8772	$523,031
2	$396,750	0.7695	$305,299
3	$203,900	0.675	$137,633
4	$203,900	0.5921	$120,729
5	$203,900	0.5194	$105,906
6	$203,900	0.4556	$92,897
7	$203,900	0.3996	$81,478
8	$203,900	0.3506	$71,487
9	$203,900	0.3075	$62,699
10	$203,900	0.2697	$54,992
		NPV	$566,051

Contemporary Technology
Year	Cash Flow (C)	PV Factor @ 14 %(F)	PV (=C x F)
0	($4,002,950)	1	($4,002,950)
1	$206,400	0.8772	$181,054
2	$399,350	0.7695	$307,300
3	$603,300	0.675	$407,228
4	$807,100	0.5921	$477,884
5	$807,100	0.5194	$419,208
6	$807,100	0.4556	$367,715
7	$990,800	0.3996	$395,924
8	$1,991,550	0.3506	$698,237
9	$1,991,550	0.3075	$612,402
10	$1,991,550	0.2697	$537,121
		NPV	$401,122

	NPV
Traditional Equipment	$566,051
Contemporary Technology	$401,122

     3.

The company should use 14 % cost of capital to compute NPV.

4.

Traditional Equipment
Year	Cash Flow (C)	PV Factor @ 14 %(F)	PV (=C x F)
0	($990,100)	1	($990,100)
1	$596,250	0.8772	$523,031
2	$396,750	0.7695	$305,299
3	$101,950	0.675	$68,816
4	$101,950	0.5921	$60,365
5	$101,950	0.5194	$52,953
6	$101,950	0.4556	$46,448
7	$101,950	0.3996	$40,739
8	$101,950	0.3506	$35,744
9	$101,950	0.3075	$31,350
10	$101,950	0.2697	$27,496
		NPV	$202,140

NPV is $ 202,140

As NPV of Traditional Equipment ($202,140) is less than that of Contemporary Technology ($401,122),

Contemporary Technology should be preferred.