You are the CFO of Harvard Manufacturing Co. and two project managers proposed their projects to you:
Question:
You are the CFO of Harvard Manufacturing Co. and two project managers proposed their projects to you:
Manager A: A 5-year project with initial investment (Year 0) of -$100,000. Year 1 projected revenue is $100,000, year 2 $100,000, Year 3 $50,000 and year 4 $90,000. The cost of goods sold for year 1-4 is 25% of revenues, SG&A expense is 15% of revenues, no interest expenses, Corporate tax rate is 35%. The project is over after with no more cash flows.
Manager B: These are the projected cash flows for the project.
Year
0 - (100,000)
1- 15,000
2 - 25,000
3 - 25,000
4- 24,000
5- 19,000
6- 19,000
7- 13,000
8- 19,000
Questions 1: If the company’s required rate of return is 10%, what are the NPV and IRR of the two projects? (Please show your calculations.)
Questions 2: Based on the question 1, which project will you choose? (The two projects are mutual exclusive.) Please provide your reasons with supporting numbers.
Questions 3: After examination, you realize the required return for manager B’s project is actually 15% due to higher risk. If this is the case, which project would you choose based on IRR and NPV? (RR for manager A is still 10%.) Support your decisions with calculations and numbers.
Question 4; Yale Bancorp came to visit you and offer an annual compounding zero-coupon bond to finance your projects. The terms of the bond are you receive $100,000 today but you will have to repay at the end of the project with $175,000. If the YTM is 10%, would you accept this bond for project A? Project B? (Ignore your decisions from Q1-3, based your decisions on the terms of the bond only.)
Fundamentals of corporate finance
ISBN: 978-0470876442
2nd Edition
Authors: Robert Parrino, David S. Kidwell, Thomas W. Bates