You have recently been hired by ABC corporation and your first assignment is to
ID: 2765280 • Letter: Y
Question
You have recently been hired by ABC corporation and your first assignment is to help them decide which of these two options should be pursued. You would like to apply the capital budgeting and Time Value Money concepts you have learnt in FIN 301 to analyze the soltion and present it to your boss in three days.
ABC Corporation has a machine that requires repairs or should be replaced. ABC has evaluated the two options and calculated the cash flows resulting from each option as follows:
Option A: Repair the Machine
Year Cash Flow
0 -51,000
1 17,400
2 21,100
3 18,700
4 18,100
5 12,300
Option B: Buy a new Machine
Year Cash Flow
0 -410,000
1 52,300
2 165,000
3 108,800
4 125,300
5 124,900
Conduct the analysis and calculate
1 payback
2 IRR
3 NPV
4 PI
for each option at three WACC points of:
10%
12%
15%
Finally, plot NPV profile charts for both Option A and B on a single graph for comparision
Explanation / Answer
1 payback: computation of pay back period for the 2 options
The payback period occurs when the cumulative cash flows changes from negative to positive. That is, it occurs between years 2 and 3in option A and 3 and 4 in option B.
Because we still have to recover 12,500 after second year in option A and 83,900 in option B
the payback period is:
2 + 12,500/18,700 = 2.67 years for option A and
for option B = 3 + 83,900 / 125,300 = 3.67 years for option B
3.NPV: for cost of capital 10%
NPV: for cost of capital 12%
NPV: for cost of capital 15%
4. PI = present value of cash flows / initial investment
2. IRR of the 2 options
For option A, NPV is positive for aa 3 cost of capital , now we weill calculate cost of capital @ 22% and 23%
IRR = 22 + 465 / 465 + 588.6 = 22 + 465 / 1053.6
=22+0.44 = 22.44% IRR for option A
now, let us compute IRR for option B
at 10 % = 18,682.3 and at 12% = -3,941.7
2% = 22,624 9that we got by 18,682.3 + 3941.7)
? = 18,682.3 = 18,682.3 * 2% / 22,624 = 1.65%
Theefore IRR for option B= 10 + 1.65 = 11.65%
Year Option A: Repair the Machine Option B: Buy a new Machine Cash flows cumulative cash flows Cash flows cumulative cash flows 0 -51,000 -51,000 -410,000 -410,000 1 17,400 -33,600 52,300 -357,700 2 21,100 -12,500 165,000 -192,700 3 18,700 6,200 108,800 -83,900 4 18,100 24,300 125,300 41,400 5 12,300 36,600 124,900 166,300Related Questions
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