21-30 NPV, IRR, and sensitivity analysis.Crumbly Cookie Company is considering e

Question

21-30

NPV, IRR, and sensitivity analysis.Crumbly Cookie Company is considering expanding by buying a new (additional) machine that costs $62,000, has zero terminal disposal value, and has a 10-year useful life. It expects the annual increase in cash revenues from the expansion to be $28,000 per year. It expects additional annual cash costs to be $18,000 per year. Its cost of capital is 8%. Ignore taxes.

Required

1. Calculate the net present value and internal rate of return for this investment.
2. Assume the finance manager of Crumbly Cookie Company is not sure about the cash revenues and costs. The revenues could be anywhere from 10% higher to 10% lower than predicted. Assume cash costs are still $18,000 per year. What are NPV and IRR at the high and low points for revenue?

Explanation / Answer

1. calculate NPV
NPV = -62000 + (28000-18000)/1.08 + 10000/1.082 +.........+10000/1.0810 = 5090

IRR calculation

62000 = 10000 (1/r + 1/r2 + .........+ 1/r10) implies r = 9.79%

2. 10% higher revenue = 30800....cash flow at +10% revenue = 30800-18000 = 12800

calculate NPV and IRR as done above

10% lower revenue = 25920....cash flow = 25920 - 18000 = 7920

repeat same procedure for NPV and IRR

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