The Tire Manufacturing Company is currently earning an average before-tax return

Question

The Tire Manufacturing Company is currently earning an average before-tax return of 25% on its total investment. The board of directors of the tire manufacturing company is considering three proposals as given in the table below. 6. Cash Flows End of Year Proposal A B Proposal C $40 000 18 000 18 000 18 000 18 00o $60 000 25 000 25 000 25 00o 25 0OO $50 000 27 000 27 00o 27 000 27 000 2 3 Proposal A is for a new system of conveyors that will replace the existing conveyors; the conveyors are xital to the tire's production. Proposal B is for a plant expansion. Proposal C is for implementing a new product line of. light truck tires. There is a high probability that this product could fail in the marketplace, resulting in the loss of most of the S50 000 initial investments. The board feels that they would need at least a 40% rate of return on this project to compensate for its additional riskiness. Which of these three proposals are acceptable by comparing the NPV? a. A b. ? c. C

Explanation / Answer

Option C

NPVA=(-40000/(1+0.4)^0)+(18000/(1+0.4)^1)+(18000/(1+0.4)^2)+(18000/(1+0.4)^3)+ (18000/(1+0.4)^4)=-6713.9

NPVB=(-60000/(1+0.4)^0)+(25000/(1+0.4)^1)+(25000/(1+0.4)^2)+(25000/(1+0.4)^3)+ (25000/(1+0.4)^4)= -13769

NPVC=(-50000/(1+0.4)^0)+(27000/(1+0.4)^1)+(27000/(1+0.4)^2)+(27000/(1+0.4)^3)+ (27000/(1+0.4)^4) = -70.84

Based on net present value, the proposal C needs to be selected as its NPV is higher than A and B

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