Reading 28: Capital Budgeting LOS c～ Q6 only, recommend, remodeling, difference

youzizhang

 

Q6. Haggerty is using the replacement-chain method, depending only on data from the new factory fact sheet and the cash-flow estimate for the remodeling projects. Which strategy should Haggerty recommend, and what is the difference between that project’s NPV and that of the other project?

Project                                          NPV difference

A) New Factory                                   $1.09 million

B) New Factory                                  $1.24 million

C) Remodeling                                   $3.69 million

 

[此贴子已经被作者于2009-3-4 9:44:42编辑过]

youzizhang

 

Correct answer is B) fficeffice" />

In order to answer this question, we must determine the NPV for both projects, running the three-year remodeling projects consecutively.

New Factory
	Sales	Fixed Costs	Variable Costs	Pretax Cash Flow	After-Tax Cash Flow	Equipment	Working Capital	Building	Depreciation	Cash Flow
Initial								-$85		-$85
Year 1						-$20			$8.33	-$17.17
Year 2	$102.5	$32.5	$41	$29	$19.14		-$7.5		$11.68	$15.61
Year 3	$205	$65	$82	$58	$38.28				$11.68	$42.45
Year 4	$205	$65	$82	$58	$38.28				$11.68	$42.45
Year 5	$205	$65	$82	$58	$38.28				$11.68	$42.45
Year 6	$205	$65	$82	$58	$38.28	$3.25	$7.5	$35	$11.68	$88.00

 

youzizhang

 

All numbers are in millionsfficeffice" />

Project	Initial	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Cost of Capital	NPV
New Factory	-$85	-$17.17	$15.61	$42.45	$42.45	$42.45	$88.00	14.3%	$26.09
Factory Upgrade	-$30	$15	$17	$28				14.3%	$14.89
Factory Upgrade				-$30	$15	$17	$28	14.3%	$14.89
Combined Upgrade Projects	-$30	$15	$17	-$2	$15	$17	$28	14.3%	$24.86

All numbers are in millions, excluding percentages

The new factory has a higher NPV than would remodeling the two factories consecutively. As such, Haggerty should recommend the new factory. The difference between the NPVs of the two strategies is $1.235 million, rounded up to $1.24 million.