Contact Manufacturing Inc. is considering two alternative investment proposals. manufacturing facility. The second involves replacing just a few obsolete pieces one project or the other this year! but not both. The cash flows associated with project cash flows at 1" percent.
Year 0 1 2 3 4 5
Renovate ($9,000,000) 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000
Replace ($2,400,000) 2,000,000 800,000 200,000 200,000 200,000
1. Calculat Calculate e the payba payback ck period period of each project project and based based on on the criter criteria ia for whi
Year
Renovate
Replace
0 ($9,000,000) ($2,400,000) 1 3,000,000 2,000,000 2 3,000,000 800,000 3 3,000,000 200,000 4 3,000,000 200,000 5 3,000,000 200,000 payback period 3 1.5 based on payback criteria replacement would be recommended as it has
#. Calculat Calculate e the net present value $%&'( $%&'( of of each project project and based based on this this criter criter acceptance? Year Renovate Replace 0 1 2 3 4 5
($9,000,000) ($2,400,000) 3,000,000 2,000,000 3,000,000 800,000 3,000,000 200,000 3,000,000 200,000 3,000,000 200,000 NPV 1,5!,"!5 #$%,335 based on NPV NPV criteri criteria a renovati renovation on would would be recomme recommended nded as it has hi&h
. Calculate the internal rate of return $I22( of each project and based on this c acceptance? Year
Renovate
Replace
0 1 2 3 4 5
($9,000,000) ($2,400,000) 3,000,000 2,000,000 3,000,000 800,000 3,000,000 200,000 3,000,000 200,000 3,000,000 200,000 'RR #( #"( based on 'RR criteria replacement would be recommended as it has hi& ). Calculate the profitability inde* $&I( of each project and based on this criteria
Year
Renovate
Replace
0 ($9,000,000) ($2,400,000) 1 3,000,000 2,000,000 2 3,000,000 800,000 3 3,000,000 200,000 4 3,000,000 200,000 5 3,000,000 200,000 Pro)itability inde* 1.11+" 1.1#! based on P' criteria replacement would be recommended as it has hi&he ". +verall! you should find conflicting recommendations based on the various cri -he rankin&s provide mi*ed si&nals because o) the di))erin& cash )low p proects. Proects that have lower initial investments and return their c have hi&her 'RRs, as is the case with the Replace proect. -. Chart the %&' profiles of these projects. abel the intersection points on the COST OF CAPITAL
0% 10% 15% 20% 25% 30%
NPV OF RENOVATION
NPV OF REPLACEMENT
!,, #,3+#,3! 1,5!,"!5 #$,1!" %3#,1! 1,!%3,#%1
1,, "%,3$% #$%,335 11",+$% 3$,1"" 1+3,#"1
35% 40% 45% 50%
#,3",11! #,$%",5$ 3,3+3,"1$ 3,+%,1#3
#%3,"5! "1,13 "%$,1"1 5$!,$
8,000,000 6,000,000 4,000,000 2,000,000 0 -2,000,0000%
10%
15%
20%
25%
30%
35%
40%
45%
50%
-4,000,000 -6,000,000 RENOVATE
REPLACEMENT
3. 4ased on this %&' profile analysis and assuming the ,5CC is 1"6! which pro /ssumin& 0/ is 15( renovation should be recommended as at this p than replacment curve
7. 4ased on the %&' profile analysis and assuming the ,5CC is #"6! which proj /ssumin& 0/ is #5( replacement should be recommended as at this than renovation curve
8. 9iscuss the important elements to consider when deciding between these two Replacment has the hi&her P' and 'RR, but Renovation is a lar&er scale e*clusive proects are the only ones available and i) there is su))icient c accepted because it contributes the most to shareholder value.
The first proposal calls for a major renovation of the f euipment in the facility. The company will choose ach project appear below and the firm discount
ch project would you recommend accepting?
shorter payback time.
ia for which project would you recommend
r NPV.
iteria for each project! which would you recommend
er 'RR. for which project would you recommend acceptance?
r inde*. teria. ,hy is this occurring? tterns and initial investments o) the two sh )lows earlier in the li)e o) the proect tend to
and 0 a*is and the crossover point.
ect is recommended and why? oint the renovation curve is above
ect is recommended and why? point the replacement curve is above
projects. roect with a hi&her NPV. ') these mutually pital to )inance renovation, then it should be
