Jefferson Products, Inc., is considering purchasing a new automatic press brake,

Question

Jefferson Products, Inc., is considering purchasing a new automatic press brake, which costs $300,000 including installation and shipping. The machine is expected to generate net cash inflows of $80,000 per year for 10 years. At the end of 10 years, the book value of the machine will be $0, and it is anticipated that the machine will be sold for $100,000. If the press brake project is undertaken, Jefferson will have to increase its net working capital by $75,000. When the project is terminated in 10 years, there will no longer be a need for this incremental working capital, and it can be liquidated and made available to Jefferson for other uses. Jefferson requires a 12, percent annual return on this type of project and its marginal tax rate is 40 percent. Calculate the press brake's net present value. Is the project acceptable? What is the meaning of the computed net present value figure? What is the project's internal rate of return? For the press brake project, at what annual rates of return do the net present value and internal rate of return methods assume that the net cash inflows are being reinvested?

Explanation / Answer

E)

The two calculations can lead to conflicting results in the case where, for instances, two mutually exclusive projects are evaluated. While both projects could be acceptable under the NPV and IRR criteria (that is, NPV>0 and IRR>k), only one of the two projects can be accepted. In such a case the two techniques are capable of giving opposite results—one project has the higher IRR, while the other has the higher NPV. Such conflicting results can occur when the sizes of the two projects differ or the shapes of the cash inflow streams differ. The major reason for the existence of this discrepancy is that the two techniques assume different interest rates on cash inflows being returned to the project. The IRR method assumes that all cash inflows are reinvested at the IRR of the project, while the NPV method assumes reinvestment at the cost of capital. Financial economists consider the NPV method to be the better one, because the reinvestment assumption for NPV appears to be the more logical one, and also because the NPV method is more consistent with the corporate objective of value maximization.

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