-44 points Question 2 (evaluating investment projects) General Motors (or Toyota
ID: 2462085 • Letter: #
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-44 points Question 2 (evaluating investment projects) General Motors (or Toyota) is thinking of investing in new production equipment, which will cost $500 million in year zero, and will generate cost savings of $300 million in year 1, $200 million in year 2, and $150 million in year 3. After 3 years, the salvage value is zero. The cost of capital (discount rate) is 25% for General Motors and 10% for Toyota. (Due to GM's recent bankruptcy, investors are scared to lend it money, so GM has to pay much higher interest rates to attract capital). Required a) What's the NPV of this project for General Motors? million (If you get say $3.52 million, enter 3.52 not 3,520,000. If you get a negative number, e NPV = $ enter it with a minus sign, i.e., -3.52 not (3.52)) Should GM invest, based on NPV? (layes, 2=no) b) What's the NPV of this project for Toyota? NPV = $ million Should Toyota invest, based on NPV? (1-yes, 2 no) c) If you computed (a) and (b) correctly, the decisions for GM and Toyota should be different. Briefly explain why they are different. This answer has not been graded yet. DOLLExplanation / Answer
LET US SEE THE NPV FOR THE PROJECT GM
YEAR 1 2 3
NPV FACTOR @ 25% 0.7798 0.6095 0.4776
SAVINGS 300 200 150
MULTIPLY 233.94 121.90 71.64
TOTAL 233.94 + 121.90 + 71.64 = 427.48 - 500 = -72.52 NET LOSS FOR GM
LET US SEE THE NPV FOR THE PROJECT TOYOTA
YEAR 1 2 3
NPV FACTOR @ 10% 0.9053 0.8203 0.7441
SAVINGS 300 200 150
MULTIPLY 271.59 164.06 111.61
TOTAL 271.59 + 164.06 + 111.61 = 547.26 - 500 = 47.26 NET SAVINGS FOR TOYOTA.
SO WE SEE THAT IN CASE OF GM THE NET INFLOW IS NEGATIVE AND IN CASE OF TOYOTA THERE ARE POSITIVE SAVINGS. SO GM SHOULD NOT ADOPT THIS STRATEGY AND TOYOTA CAN GO FOR IT.
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