Advanced Technology, Payback, NPV, IRR, Sensitivity Analysis Gina Ripley, presid

Question

Advanced Technology, Payback, NPV, IRR, Sensitivity Analysis Gina Ripley, president of Dearing Company, is considering the purchase of a computer-aided manufacturing system. The annual net cash benefits and savings associated with the system are described as follows: The system will cost $9,000,000 and last 10 years. The company's cost of capital is 12 percent. The present value tables provided in Exhibit 19B.1 and Exhibit 19B.2 must be used to solve the following problems. Calculate the payback period for the system. Assume that the company has a policy of only accepting projects with a payback of five years or less. Would the system be acquired? Calculate the NPV and IRR for the project. Round your IRR answers to the nearest whole percentage value (for example, 15.6% rounds to 16% and should be entered as "16" in the answer box). If the NPV is negative, enter your answer as a negative value. Should the system be purchased-even if it does not meet the payback criterion? The project manager reviewed the projected cash flows and pointed out that two items had been missed. First, the system would have a salvage value, net of any tax effects, of $1,000,000 at the end of 10 years. Second, the increased quality and delivery performance would allow the company to increase its market share by 20 percent. This would produce an additional annual net benefit of $300,000. Recalculate the payback period, NPV, and IRR given this new information. (For the IRR computation, initially ignore salvage value.) Round your IRR answers to the nearest whole percentage value (for example, 15.6% rounds to 16% and should be entered as "16" in the answer box). If the NPV is negative, enter your answer as a negative value. Suppose that the salvage value is only half what is projected. Does this make a difference in the outcome? Does the salvage value have any real bearing on the company's decision?

Explanation / Answer

1. 6 years, no the system should not be acquired as the payback period is more than 5 years.

2)

PV of cash flows = Cashflow/(1+i)^n

where i is the cost of capital and n is the number of period.

System should not be purchase as npv and irr is negative.

2)

Decision will change as NPV is postive and also the payback period is 5 years

Year Cost saving per annum PV at 12% 0         (9,000,000) (9,000,000) 1                  1,500,000     1,339,286 2                  1,500,000     1,195,791 3                  1,500,000     1,067,670 4                  1,500,000         953,277 5                  1,500,000         851,140 6                  1,500,000         759,947 7                  1,500,000         678,524 8                  1,500,000         605,825 9                  1,500,000         540,915 10                  1,500,000         482,960 NPV       (524,665) IRR -1.29% Payback period 6 years

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