The Pinkerton Publishing Company is considering two mutually exclusive expansion

Question

The Pinkerton Publishing Company is considering two mutually exclusive expansion plans. Plan A calls for the expenditure of $44 million on a large-scale, integrated plant that will provide an expected cash flow stream of $6 million per year for 20 years. Plan B calls for the expenditure of $14 million to build a somewhat less efficient, more labor-intensive plant that has an expected cash flow stream of $2.7 million per year for 20 years. The firm's cost of capital is 9%. Calculate each project's NPV. Round your answers to the nearest dollar. Project A $ Project B $ Calculate each project's IRR. Round your answers to two decimal places. Project A % Project B % Set up a Project by showing the cash flows that will exist if the firm goes with the large plant rather than the smaller plant. Year Project Cash Flows 0 $ 1-20 $ What is the NPV for this Project ? Round your answer to the nearest dollar. $ What is the IRR for this Project ? Round your answer to two decimal places. %

Explanation / Answer

(I) Computation of NPV of both the plans.

(II) Find out IRR of each plan:

IRR of Plan A:

Computation of Rate-1 (R1) & Rate-2 (R2):

R1= [(Total Cash Inflow/Total Cash Outflow)-1] / (Period -1) [(120/44)-1)] / 19 = 1.727/19 = 0.09089 , we assume it at 9%

At 9%, we have solved as above.

R2= R1+(Profitabilty Index under R1-1) = 0.09+ [(55/44)-1] = 0.09 + 0.25 = 0.34 i.e. 34%

IRR for Plan A = R2+ [(V2-VM)/(V2-V1)] x (R2-R1) = 0.34 +[(-26.402)-0) /(-26.402-11.00)] x (0.09-0.34)

= 0.34+[-26.402/-37.402] x 9 - 0.25

= 0.34 +[0.7059] x -0.25 = 0.34 -0.1764 = 0.1636, i.e. 16.36%

IRR for Plan A is 16.36%

Now IRR for plan B:

R1= [(Total Cash Inflow/Total Cash Outflow)-1] / (Period -1) [(54/14)-1)] / 19 = 2.8571/19 = 0.1503 , we assume it at 15%

R2= R1+(Profitabilty Index under R1-1) = 0.15+ [(17/14)-1] = 0.15 + 0.2142 = 0.3642 i.e. we take it 36%

IRR for Plan A = R2+ [(V2-VM)/(V2-V1)] x (R2-R1) = 0.36 +[(-6.52)-0) /(-6.52-3)] x (0.04-0.36)

= 0.36+[-6.52/-9.52] x -0.32

= 0.36 +[0.6848] x -0.32= 0.36 -0.2192 = 0.1408, i.e. 14.08%

IRR for Plan B is 14.08%

Please Note: Vm where IRR is zero.

Plan A Plan A Particulars Year DF at 9% CF ($) DCF ($) CF ($) DCF ($) Intial Expenditure ($ million) 0 1 -44 -44 -14 -14 Expected Cash Inflow ($ milllion) 1 to 20 9.129 6 55 2.70 25 Net Present Value ($ million) 11 11

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