CP

Expected Net Cost

Year Conveyor Forklift

0 ($500,000) ($200,000)

1 (120,000) (160,000)

2 (120,000) (160,000)

3 (120,000) (160,000)

4 (120,000) (160,000)

5 (120,000) (160,000)

a.What is the IRR of each alternative?

b.What is the present value of costs of each alternative? Which method should be chosen?

Your division is considering two investment projects, each of which requires an up-front expen-

diture of $25 million. You estimate that the cost of capital is 10 percent and that the investments

will produce the following after-tax cash flows (in millions of dollars):

Year Project A Project B

15 20

210 10

315 8

420 6

a.What is the regular payback period for each of the projects?

b.What is the discounted payback period for each of the projects?

c.If the two projects are independent and the cost of capital is 10 percent, which project or

projects should the firm undertake?

d.If the two projects are mutually exclusive and the cost of capital is 5 percent, which project

should the firm undertake?

e.If the two projects are mutually exclusive and the cost of capital is 15 percent, which project

should the firm undertake?

f.What is the crossover rate?

g.If the cost of capital is 10 percent, what is the modified IRR (MIRR) of each project?

Shao Airlines is considering two alternative planes. Plane A has an expected life of 5 years, will

cost $100 million, and will produce net cash flows of $30 million per year. Plane B has a life of 10

years, will cost $132 million, and will produce net cash flows of $25 million per year. Shao plans to

serve the route for 10 years. Inflation in operating costs, airplane costs, and fares is expected to be

zero, and the company’s cost of capital is 12 percent. By how much would the value of the com-

pany increase if it accepted the better project (plane)?

The Perez Company has the opportunity to invest in one of two mutually exclusive machines

which will produce a product it will need for the foreseeable future. Machine A costs $10 million

but realizes after-tax inflows of $4 million per year for 4 years. After 4 years, the machine must be

replaced. Machine B costs $15 million and realizes after-tax inflows of $3.5 million per year for 8

years, after which it must be replaced. Assume that machine prices are not expected to rise be-

cause inflation will be offset by cheaper components used in the machines. If the cost of capital is

10 percent, which machine should the company use?

Filkins Fabric Company is considering the replacement of its old, fully depreciated knitting ma-

chine. Two new models are available: Machine 190-3, which has a cost of $190,000, a 3-year ex-

pected life, and after-tax cash flows (labor savings and depreciation) of $87,000 per year; and

Machine 360-6, which has a cost of $360,000, a 6-year life, and after-tax cash flows of $98,300

per year. Knitting machine prices are not expected to rise, because inflation will be offset by

7–16

UNEQUAL LIVES

7–15

UNEQUAL LIVES

7–14

UNEQUAL LIVES

7–13
PAYBACK, NPV, AND MIRR

Problems 291

The Basics of Capital Budgeting: Evaluating Cash Flows 289