Discount Rates, Quality, Market Share, Contemporary Manufacturing Environment Sw
ID: 2795519 • Letter: D
Question
Discount Rates, Quality, Market Share, Contemporary Manufacturing Environment
Sweeney Manufacturing has a plant where the equipment is essentially worn out. The equipment must be replaced, and Sweeney is considering two competing investment alternatives. The first alternative would replace the worn-out equipment with traditional production equipment; the second alternative uses contemporary technology and has computer-aided design and manufacturing capabilities. The investment and after-tax operating cash flows for each alternative are as follows:
The company uses a discount rate of 18 percent for all of its investments. The company's cost of capital is 14 percent.
The present value tables provided in Exhibit 19B.1 and Exhibit 19B.2 must be used to solve the following problems.
Required:
1. Calculate the net present value for each investment using a discount rate of 18 percent. Round intermediate calculations and the final answers to the nearest dollar. If the NPV is negative, enter your answer as a negative value.
2. Calculate the net present value for each investment using a discount rate of 14 percent. Round intermediate calculations and the final answers to the nearest dollar.
3. Which rate should the company use to compute the net present value?
4. Now, assume that if the traditional equipment is purchased, the competitive position of the firm will deteriorate because of lower quality (relative to competitors who did automate). Marketing estimates that the loss in market share will decrease the projected net cash inflows by 50 percent for Years 3–10. Recalculate the NPV of the traditional equipment given this outcome using a discount rate of 14 percent. Round intermediate calculations and your final answer to the nearest dollar.
What is the NPV now?
$
What is the decision now?
1.Contemporary technology is preferred (or)
2.Traditional equipment is preferred
Year Traditional
Equipment Contemporary
Technology 0 $(991,600) $(3,999,500) 1 607,550 208,750 2 402,050 392,400 3 207,000 605,450 4 207,000 802,600 5 207,000 802,600 6 207,000 802,600 7 207,000 997,750 8 207,000 2,008,000 9 207,000 2,008,000 10 207,000 2,008,000
Explanation / Answer
When discount rate is 18%
Year
Traditional
Year
Contemporary
Equipment
Present value of cash flow at 18% = cash flow/(1+r)^n r= 18%
Technology
Present value of cash flow at 18% = cash flow/(1+r)^n r= 18%
0
($991,600)
($991,600)
0
($3,999,500)
($3,999,500)
1
607500
514830.5085
1
208750
176906.7797
2
402050
288746.05
2
392400
281815.5702
3
207000
125986.5906
3
605450
368495.5619
4
207000
110514.5532
4
802600
413972.1512
5
207000
96942.59052
5
802600
350823.8569
6
207000
85037.36011
6
802600
297308.3533
7
207000
74594.17553
7
997750
313218.7019
8
207000
65433.48731
8
2008000
534204.6328
9
207000
57397.79589
9
2008000
452715.7905
10
207000
50348.94376
10
2008000
383657.4496
Net present value
sum of present value of cash flow
$478,232
Net present value
sum of present value of cash flow
($426,381)
When discount rate is 14%
Year
Traditional
Year
Contemporary
Equipment
Present value of cash flow at 18% = cash flow/(1+r)^n r= 14%
Technology
Present value of cash flow at 18% = cash flow/(1+r)^n r= 14%
0
($991,600)
($991,600)
0
($3,999,500)
($3,999,500)
1
607500
532894.7368
1
208750
183114.0351
2
402050
309364.4198
2
392400
301939.0582
3
207000
139719.1039
3
605450
408661.5045
4
207000
122560.6174
4
802600
475203.6306
5
207000
107509.3135
5
802600
416845.29
6
207000
94306.41537
6
802600
365653.7632
7
207000
82724.92576
7
997750
398738.1386
8
207000
72565.72435
8
2008000
703922.5821
9
207000
63654.14417
9
2008000
617475.9492
10
207000
55836.96857
10
2008000
541645.5695
Net present value
sum of present value of cash flow
$589,536
Net present value
sum of present value of cash flow
$413,700
Company should use cost of capital of 14% to compute the net present value because it is the minimum required return that a company should earn.
When discount rate is 14%
Year
Traditional
Equipment
Present value of cash flow at 18% = cash flow/(1+r)^n r= 14%
0
($991,600)
($991,600)
1
607500
532894.7368
2
402050
309364.4198
3
103500
69859.55193
4
103500
61280.30871
5
103500
53754.65676
6
103500
47153.20769
7
103500
41362.46288
8
103500
36282.86218
9
103500
31827.07209
10
103500
27918.48429
Net present value
sum of present value of cash flow
$220,098
Company will buy new contemporary technology because its NPV is greater than the traditional equipment
When discount rate is 18%
Year
Traditional
Year
Contemporary
Equipment
Present value of cash flow at 18% = cash flow/(1+r)^n r= 18%
Technology
Present value of cash flow at 18% = cash flow/(1+r)^n r= 18%
0
($991,600)
($991,600)
0
($3,999,500)
($3,999,500)
1
607500
514830.5085
1
208750
176906.7797
2
402050
288746.05
2
392400
281815.5702
3
207000
125986.5906
3
605450
368495.5619
4
207000
110514.5532
4
802600
413972.1512
5
207000
96942.59052
5
802600
350823.8569
6
207000
85037.36011
6
802600
297308.3533
7
207000
74594.17553
7
997750
313218.7019
8
207000
65433.48731
8
2008000
534204.6328
9
207000
57397.79589
9
2008000
452715.7905
10
207000
50348.94376
10
2008000
383657.4496
Net present value
sum of present value of cash flow
$478,232
Net present value
sum of present value of cash flow
($426,381)
When discount rate is 14%
Year
Traditional
Year
Contemporary
Equipment
Present value of cash flow at 18% = cash flow/(1+r)^n r= 14%
Technology
Present value of cash flow at 18% = cash flow/(1+r)^n r= 14%
0
($991,600)
($991,600)
0
($3,999,500)
($3,999,500)
1
607500
532894.7368
1
208750
183114.0351
2
402050
309364.4198
2
392400
301939.0582
3
207000
139719.1039
3
605450
408661.5045
4
207000
122560.6174
4
802600
475203.6306
5
207000
107509.3135
5
802600
416845.29
6
207000
94306.41537
6
802600
365653.7632
7
207000
82724.92576
7
997750
398738.1386
8
207000
72565.72435
8
2008000
703922.5821
9
207000
63654.14417
9
2008000
617475.9492
10
207000
55836.96857
10
2008000
541645.5695
Net present value
sum of present value of cash flow
$589,536
Net present value
sum of present value of cash flow
$413,700
Company should use cost of capital of 14% to compute the net present value because it is the minimum required return that a company should earn.
When discount rate is 14%
Year
Traditional
Equipment
Present value of cash flow at 18% = cash flow/(1+r)^n r= 14%
0
($991,600)
($991,600)
1
607500
532894.7368
2
402050
309364.4198
3
103500
69859.55193
4
103500
61280.30871
5
103500
53754.65676
6
103500
47153.20769
7
103500
41362.46288
8
103500
36282.86218
9
103500
31827.07209
10
103500
27918.48429
Net present value
sum of present value of cash flow
$220,098
Company will buy new contemporary technology because its NPV is greater than the traditional equipment
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