Question

In: Finance

In year 0 of project A, your company is required to make $1M investment but in...

In year 0 of project A, your company is required to make $1M investment but in year 1, 2, 3, 4, 5, and 6 the investment level is only $250K per year. Benefits are forecasted to start in year 3 and continue for the next 20 years varying by each year. Breakeven period is somewhere between year 6 and 7. There is another project alternative (call it project B) that is known but not pursued because the payback period is after year 10 and so the current engineering manager assigned to conduct the economic analysis did not consider this alternative. (a) Should the company invest the time and effort in conducting an analysis for the alternative project? Why or Why not? (b) Create a spreadsheet to show a reasonable analysis for the 20-year period. Use numbers provided and make-up numbers that have not been provided to you as part of this question.

Solutions

Expert Solution

(a): Yes, the company should certainly invest the time and effort in conducting an analysis for the alternative project. This is because while the alternate project is less attractive on the payback criteria it may be more attractive on other capital budgeting criteria like NPV analysis or IRR analysis. It should be noted that payback method is not a superior method of capital budgeting as it does not consider the time value of money.

(b): Reasonable analysis for 20 year period for both projects A and B is done below in terms of NPV analysis and assuming the cost of capital to be 10%.

For A:

B:

Thus we can see that in terms of payback project A is attractive while in terms of NPV project B is more attractive. As NPV is a better capital budgeting tool (since 10% cost of capital and time value of money is considered) we can say that project B is superior when compared to project A.


Related Solutions

Company X has an investment project requiring a $10m investment today and that has a $1m...
Company X has an investment project requiring a $10m investment today and that has a $1m net present value. The company has 1 million shares, no internal funds and, given the nature of its business, cannot get debt financing. Hence it must raise funds by issuing equity or abandon the project. While the market knows all about the investment project, it does not know whether the value of the company’s existing assets (i.e., excluding the new project) is $10m or...
Company X has an investment project requiring a $10m investment today and that has a $1m...
Company X has an investment project requiring a $10m investment today and that has a $1m net present value. The company has 1 million shares, no internal funds and, given the nature of its business, cannot get debt financing. Hence it must raise funds by issuing equity or abandon the project. While the market knows all about the investment project, it does not know whether the value of the company’s existing assets (i.e., excluding the new project) is $10m or...
Project A Project B Cost of equipment required $ 155,000 $ 0 Working capital investment required...
Project A Project B Cost of equipment required $ 155,000 $ 0 Working capital investment required $ 0 $ 155,000 Annual cash inflows $ 25,000 $ 40,000 Salvage value of equipment in six years $ 8,600 $ 0 Life of the project 6 years 6 years The working capital needed for project B will be released at the end of six years for investment elsewhere. Perit Industries’ discount rate is 14%. Click here to view Exhibit 12B-1 and Exhibit 12B-2,...
Consider the following investment project: Year 0 1 2 Cash Flow -250 600 -360 Make an...
Consider the following investment project: Year 0 1 2 Cash Flow -250 600 -360 Make an NPV Profile and graph the NPV with a discount rate equal to 0%, 5%, 10%, 15%, 20%, 25% and 30% to determine approximately where the IRR’s are for this project and indicate when this project should be accepted.
Here are the net cash flows for a project your company is considering: Year 0 =...
Here are the net cash flows for a project your company is considering: Year 0 = -1000 Year 1 = 250 Year 2 = 449 Year 3 = 800 Year 4 = 500 Year 5 = 500 If the payback period with interest is 3 years, for what range of interest rates is this project worth doing (start your analysis with an interest rate of 0%)? ** Kindly just don’t directly draw the table with values in it, it’ll be...
Here are the net cash flows for a project your company is considering: Year 0 =...
Here are the net cash flows for a project your company is considering: Year 0 = -1000 Year 1 = 250 Year 2 = 449 Year 3 = 800 Year 4 = 500 Year 5 = 500 If the payback period with interest is 3 years, for what range of interest rates is this project worth doing (start your analysis with an interest rate of 0%)? ** Kindly just don’t directly draw the table with values in it, it’ll be...
What is the NPV of this project if the required rate is 7%? Year       CF 0         ...
What is the NPV of this project if the required rate is 7%? Year       CF 0          -$1312 1           $743 2           $1757 3           $2148
Your company is considering a new 3-year project that requires an initial investment in equipment of...
Your company is considering a new 3-year project that requires an initial investment in equipment of $3 million. Prior to this, you had engaged a consultant to study the feasibility of the new project and after an extensive market survey, the consultant confirmed your belief that the project would be viable. Your company is charged $100,000 for the feasibility study. The equipment will be depreciated straight line to zero over the 3 years of its useful life. In addition, you...
Your company is considering a new 3-year project that requires an initial investment in equipment of...
Your company is considering a new 3-year project that requires an initial investment in equipment of $3 million. Prior to this, you had engaged a consultant to study the feasibility of the new project and after an extensive market survey, the consultant confirmed your belief that the project would be viable. Your company is charged $100,000 for the feasibility study. The equipment will be depreciated straight line to zero over the 3 years of its useful life. In addition, you...
A firm is considering an investment project with the following cash flows: Year 0 = -$110,000...
A firm is considering an investment project with the following cash flows: Year 0 = -$110,000 (initial costs); Year 1= $40,000; Year 2 =$90,000; and Year 3 = $30,000; and Year 4 = $60,000. The company has a 10% cost of capital. What is the project’s discounted payback? 1.67 years 1.86 years 1.99 years 2.08 years A firm is considering an investment project with the following cash flows: Year 0 = -$110,000 (initial costs); Year 1= $40,000; Year 2 =$90,000;...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT