A Company is considering two alternative methods of producing a new product. The
ID: 2708729 • Letter: A
Question
A Company is considering two alternative methods of producing a new product. The relevant data concerning the alternatives are presented below.
Alternative I Alternative II
Initial Investment $50,000 $110,000
Annual receipts $36,000 $50,000
Annual Disbursements $16,000 $10,000
Annual depreciation $12,000 $16,000
Expected Life 5 years 7 years
Salvage Value $0 $0
At the end of the useful life of whatever equipment is chosen, the product will be discontinued. The company's tax rate is 50 percent, and its cost of capital is 11 percent.
Calculate the Net Present Value of each alternative.
Answer
$4,276 ; $11,123
$9,136 ; $21,936
$13,236 ; $22, 577
$913.60 ; $2,193.60
Calculate the internal rate of return for each alternative. Answer
Of the two Alternatives from questions one and two, which Alternative should the company chose?
Both
Neither
a.
$4,276 ; $11,123
b.$9,136 ; $21,936
c.$13,236 ; $22, 577
d.$913.60 ; $2,193.60
Explanation / Answer
Alternative 1
Annual net income = (36000-16000-12000)*(1-50%) = 4000
Annual cashflow = net income+depreciation = 4000+12000 = 16000
So NPV = -50,000 + 16,000/1.11^1 + 16,000/1.11^2 + 16,000/1.11^3 + 16,000/1.11^4 + 16,000/1.11^5 = 9136
Alternative 2
Annual net income = (50000-10000-16000)*(1-50%) = 12000
Annual cashflow = net income+depreciation = 12000+16000 = 28000
So NPV = -110,000 + 28,000/1.11^1 + 28,000/1.11^2 + 28,000/1.11^3 + 28,000/1.11^4 + 28,000/1.11^5 + 28,000/1.11^6 + 28,000/1.11^7 = 21,936
So the answer is choice (b): $9,136 ; $21,936
Let IRR of Alternate 1 = x%
So -50,000 + 16,000/(1+x)^1 + 16,000/(1+x)^2 + 16,000/(1+x)^3 + 16,000/(1+x)^4 + 16,000/(1+x)^5 = 0
Solving, we get x=IRR for Alternative 1 = 18%
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.