Homework SourseDiscount Rates Quality Market Share Contemporary Manufacturi
Discount Rates, Quality, Market Share, Contemporary Manufacturing Environment
Sweeney Manufacturing has a plant where the equipment is essentially worn out. The equipment must be replaced, and Sweeney is considering two competing investment alternatives. The first alternative would replace the worn-out equipment with traditional production equipment; the second alternative uses contemporary technology and has computer-aided design and manufacturing capabilities. The investment and after-tax operating cash flows for each alternative are as follows:
The company uses a discount rate of 18 percent for all of its investments. The company\'s cost of capital is 14 percent.
The present value tables provided in Exhibit 19B.1 andExhibit 19B.2 must be used to solve the following problems.
Required:
1. Calculate the net present value for each investment using a discount rate of 18 percent. Round intermediate calculations and the final answers to the nearest dollar. If the NPV is negative, enter your answer as a negative value.
2. Calculate the net present value for each investment using a discount rate of 14 percent. Round intermediate calculations and the final answers to the nearest dollar.
3. Which rate should the company use to compute the net present value?
The 14% cost of capital
4. Now, assume that if the traditional equipment is purchased, the competitive position of the firm will deteriorate because of lower quality (relative to competitors who did automate). Marketing estimates that the loss in market share will decrease the projected net cash inflows by 50 percent for Years 3–10. Recalculate the NPV of the traditional equipment given this outcome using a discount rate of 14 percent. Round intermediate calculations and your final answer to the nearest dollar.
What is the NPV now?
$________________
Year | Traditional Equipment | Contemporary Technology |
| 0 | $(1,000,000) | $(4,000,000) |
| 1 | 600,000 | 200,000 |
| 2 | 400,000 | 400,000 |
| 3 | 200,000 | 600,000 |
| 4 | 200,000 | 800,000 |
| 5 | 200,000 | 800,000 |
| 6 | 200,000 | 800,000 |
| 7 | 200,000 | 1,000,000 |
| 8 | 200,000 | 2,000,000 |
| 9 | 200,000 | 2,000,000 |
| 10 | 200,000 | 2,000,000 |
Solution
SOLUTION TO Q1
TRADITIONAL EQUIPMENT
SOLUTION TO QUESTION 2
Thus a discount rate of 14% should be opted for
(NPV=Cash inflow- cash outflow)
(Note:the cash flow from year 3-10 is taken as exactly half of the projected cash flow)
| SOLUTION TO Q1 TRADITIONAL EQUIPMENT | CONTEMPORARY TECHNOLOGY | |||||||||||
| When the discount rate is 18% | When the discount rate is 18% | |||||||||||
| YEAR | CASH FLOW | @ 18% | cash inflow in $ | YEAR | CASH FLOW | @ 18% | cash inflow in $ | |||||
| 1 | 600000 | 0.847457627 | 508475 | 1 | 200000 | 0.847458 | 169492 | |||||
| 2 | 400000 | 0.71818443 | 287274 | 2 | 400000 | 0.718184 | 287274 | |||||
| 3 | 200000 | 0.608630873 | 121726 | 3 | 600000 | 0.608631 | 365179 | |||||
| 4 | 200000 | 0.515788875 | 103158 | 4 | 800000 | 0.515789 | 412631 | |||||
| 5 | 200000 | 0.437109216 | 87422 | 5 | 800000 | 0.437109 | 349687 | |||||
| 6 | 200000 | 0.370431539 | 74086 | 6 | 800000 | 0.370432 | 296345 | |||||
| 7 | 200000 | 0.313925033 | 62785 | 7 | 1000000 | 0.313925 | 313925 | |||||
| 8 | 200000 | 0.266038164 | 53208 | 8 | 2000000 | 0.266038 | 532076 | |||||
| 9 | 200000 | 0.225456071 | 45091 | 9 | 2000000 | 0.225456 | 450912 | |||||
| 10 | 200000 | 0.191064467 | 38213 | 10 | 2000000 | 0.191064 | 382129 | |||||
| TOTAL CASH INFLOW | 1381438 | TOTAL CASH INFLOW | 3559650 | |||||||||
| CASH OUTFLOW | 1000000 | CASH OUTFLOW | 4000000 | |||||||||
| NPV(in dollars) | 381438 | NPV(in dollars) | -440350 | (negative cash inflow) | ||||||||
| (NPV=Cash inflow- cash outflow) | (NPV=Cash inflow- cash outflow) | |||||||||||
