AOL is considering two proposals to overhaul its network infrastructure. They have received two bids. The first bid, from Huawei, will require a $20 million upfront investment and will generate $20 million in savings for AOL each year for the next three years. The second bid, from Cisco, requires a $100 million upfront investment and will generate $60 million in savings each year for the next three years.
a. What is the IRR for AOL associated with each bid?
b. If the cost of capital for this investment is 12%, what is the NPV for AOL of each bid? Suppose Cisco modifies its bid by offering a lease contract instead. Under the terms of the lease, AOL will pay $20 million upfront, and $35 million per year for the next three years. AOL's savings will be the same as with Cisco's original bid.
c. Including its savings, what are AOL's net cash flows under the lease contract? What is the IRR of the Cisco bid now?
d. Is this new bid a better deal for AOL than Cisco's original bid? Explain.