Diane is a financial analyst working for a large chain of discount retail stores

Question

Diane is a financial analyst working for a large chain of discount retail stores. Her company is looking at the possiblity of replacing the existing fluourescent lights in all of its stores with LED lights. The main advantage of making this switch is that the LED lights are much more efficient and will be replaced after 10 years, whereas the existing lights have to be replaced after five years. Of couse, making this change will require a large investment to purchase new LED lights and to pay for the labor of switching out tens of thousands of bulbs. Diane plans to use a 10 year horizon to analyze this proposal, figuring that changes to lighting technology will eventually make this investment obsolete.

Diane's friend and coworker, David has analyzed another energy-saving investment opportunity that involves replacing outdoor lighting with solar-powered fixtures in a few of the company's stores. David also used a 10 year horizon to conduct his analysis. Cash flow forecasts for each project appear below. The company uses a 10% discount rate to analyze capital budgeting proposals.

A. What is the NPV of each investment? Which investment (if either) should the company underttake?

B. David approaches Diane for a favor. David says the solar lighting project is a pet project of his boss. He suggests to Diane they they roll their two projects into a single proposal. The cash flows for this combined project would simply equal the sum of the two individual projects. Calculate the NOV of the combined project. Does it appear to be worth doing? Would you reccomend investing in the combined project?

C. What is the ethical issue that Diane faces? Is any harm donw if she does the favor for David as he asks?

C. What is the ethical issue that Diane faces? Is any harm done if she does the favor for David as he asks?

Year LED Project Solar Project 0 (4,200,000) (500,000) 1 700,000 60,000 2 700,000 60,000 3 700,000 60,000 4 700,000 60,000 5 1,000,000 60,000 6 700,000 60,000 7 700,000 60,000 8 700,000 60,000 9 700,000 60,000 10 700,000 60,000

Explanation / Answer

Solution:

Company should undertake LED Project as investment, as the NPV is positive in this case.

B.

Year LED Project PVIF(10%) Present Value of Cashflows Solar Project PVIF(10%) Present Value of Cashflows 0 -4,200,000 1.000 -4,200,000 -500,000 1.000 -500,000 1 700,000 0.909 636,364 60,000 0.909 54,545 2 700,000 0.826 578,512 60,000 0.826 49,587 3 700,000 0.751 525,920 60,000 0.751 45,079 4 700,000 0.683 478,109 60,000 0.683 40,981 5 1,000,000 0.621 620,921 60,000 0.621 37,255 6 700,000 0.564 395,132 60,000 0.564 33,868 7 700,000 0.513 359,211 60,000 0.513 30,789 8 700,000 0.467 326,555 60,000 0.467 27,990 9 700,000 0.424 296,868 60,000 0.424 25,446 10 700,000 0.386 269,880 60,000 0.386 23,133 Intital Investment -4,200,000 -500,000 Total Present value of Cash flows 4,487,473 368,674 NPV = Total Present value of Cash flows - Intital Investment 287,473 -131,326

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