Problem 1 (24 points) A large food corporation is considering the development an

Question

Problem 1 (24 points) A large food corporation is considering the development and production of three types of beverages, ranging juices to instant drinks. The type of markets, margins of proft, sales volume and technology needed are quite different in each case. The following summarizes the economic aspects of the projects Project 1Project 2 Project 3 $597,500 Equipment costs Installation costs $446,100 150,000 145,000 168,000 $435,700 200,000 250,000 Expected annual profits 212,000 If MARR is 12% and the projects' lives will be 6 years. a. What is the decision criterion? (2 pts) Which alternative is the most profitable? (16 pts) . Use b. flow diagram(s) and the necessary equivalent Remember to clearly show the cash model(s). (6 pts)

Explanation / Answer

Project 1 Project 2 Project 3 Equipment Cost 597500 446100 435700 Installtion costs 250000 150000 200000 Expected Annual profits 212000 145000 168000 MARR 12% Life 6 Yrs Salavage Value Assumed 0 Project 1 Year 0 1 2 3 4 5 6 Equipment Cost -597500 Installtion costs -250000 Expected Annual profits 212000 212000 212000 212000 212000 212000 Net Cash Flow -847500 212000 212000 212000 212000 212000 212000 Rate at which NPV becomes Zero is IRR Rate 13.00% PV Factor =1/(1+13%)^0 =1/(1+13%)^1 =1/(1+13%)^2 =1/(1+13%)^3 =1/(1+13%)^4 =1/(1+13%)^5 =1/(1+13%)^6 PV Factor 1 0.884962205 0.783158104 0.693065322 0.613336615 0.542779723 0.48033954 PV (PV factor x net cash flow of year) -847500.00 187611.99 166029.52 146929.85 130027.36 115069.30 101831.98 NPV 0.00 IRR 13% Project 2 Year 0 1 2 3 4 5 6 Equipment Cost -446100 Installtion costs -150000 Expected Annual profits 145000 145000 145000 145000 145000 145000 Net Cash Flow -596100 145000 145000 145000 145000 145000 145000 Rate at which NPV becomes Zero is IRR Rate 12.00% PV Factor =1/(1+12%)^0 =1/(1+12%)^1 =1/(1+12%)^2 =1/(1+12%)^3 =1/(1+12%)^4 =1/(1+12%)^5 =1/(1+12%)^6 PV Factor 1 0.892831616 0.797148295 0.711719201 0.635445404 0.567345748 0.506544221 PV (PV factor x net cash flow of year) -596100.00 129460.58 115586.50 103199.28 92139.58 82265.13 73448.91 NPV 0.00 IRR 12% Project 3 Year 0 1 2 3 4 5 6 Equipment Cost -435700 Installtion costs -200000 Expected Annual profits 168000 168000 168000 168000 168000 168000 Net Cash Flow -635700 168000 168000 168000 168000 168000 168000 Rate at which NPV becomes Zero is IRR Rate 15% PV Factor =1/(1+12%)^0 =1/(1+12%)^1 =1/(1+12%)^2 =1/(1+12%)^3 =1/(1+12%)^4 =1/(1+12%)^5 =1/(1+12%)^6 PV Factor 1 0.869524106 0.756072171 0.657422979 0.571645128 0.497059219 0.432204973 PV (PV factor x net cash flow of year) -635700 146080.0498 127020.1248 110447.0605 96036.38153 83505.94881 72610.4355 NPV 0.000922079 IRR 15% Decision Criterion - IRR should be greater than MARR of 12%. Project 3 Has an IRR of 15% and that is the most profitable.

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