a. Cuenca Company is considering the purchase of new equipment that will speed u

Question

a. Cuenca Company is considering the purchase of new equipment that will speed up the process for producing flash drives. The equipment will cost $7,200,000 and have a life of five years with no excepted salvage value. The expected cash flows associated with the project follow:

Year Cash revenue Cash Expenses

1 $8,000,000 $6,000,000

28,000,000 6,000,000

38,000,000 6,000,000

4 8,000,0006,000,000

5 8,000,000 6,000,000

b. Kathy Shorts is evaluting an investment in an information system that will save $240,000 per year. She estmates that the system will last 10 years. The system will cost $1,248,000. Her company's cost of capital is 10 percent.

c. Elmo Enterprises just announced that a new plant would be built in Helper, Utah. Elmo told its shareholders that the plant has an expected life of 15 years and an expected IRR equal to 25 percent. The cost of building the plant is expected to be $2,880,00.

1. Calculate the IRR for Cuenca Company. The company's cost of capital is 16 percent. Sould the new equipment be purchased?

2.Calculate Kathy Short's IRR. Should she acquire the new system?

3. What should be Elmo Enterprises' expected annual cash flow from the plant?

Explanation / Answer

IRR _ Cuenca = 12%

As IRR<Cost of capital, hence the new equipment should not be purchased

IRR _ Kathy = 14%

IRR>Cost of Capital, hence it should acquire the new system

Expected Annual Cash Flow = $746,256.57

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