# Question

Wildcat Welders, Inc., manufactures new and repairs old irrigation sprinkler systems in the Okanogan Valley. The company has been plagued with industrial accidents involving its old welding technology. A new, safer welding robot has been developed that will reduce labor costs, worker insurance costs, and direct materials costs. The investment would be $10 million. The annual cash savings would be $7 million, but it would cost $2 million a year to operate the machine. The robots have an 8-year useful life with a terminal value of $1 million. The robots qualify for the 7-year MACRS schedule. Inflation is estimated to be 5% per year. The risk-free rate is estimated to be 4%, and the company’s managers require a minimum risk premium of 6%. Wildcat’s marginal income tax rate is 25%.

REQUIRED

A. Develop a spreadsheet to calculate the NPV of this project, using the nominal rate method.

Be sure to include a data input box at the top of the spreadsheet to allow for sensitivity analysis.

B. Identify a qualitative factor that could potentially override a negative NPV in making the decision to buy this equipment. Explain.

C. Alter the risk premium to perform sensitivity analyses, and answer the following questions:

1. Explain how you decided which values of the risk premium were reasonable to investigate.

2. Describe how changing the risk premium affects the net present value for this project.

3. The new equipment would most likely lower Wildcat’s risk of future lawsuits because of the reduced accident rate. Explain how this factor affects your assessment of the appropriateness of the risk premium.

D. Because Wildcat is uncertain about whether the annual cash savings from the equipment would be $7 million alter the cash savings to perform sensitivity analyses and answer the following questions:

1. Explain how you decided which values of the cash savings were reasonable to investigate.

2. Describe how changing the cash savings affects the net present value for this project.

3. Identify the level of cash savings that results in an NPV of zero.

E. Current inflation is 2%. Given this information, how reasonable is the inflation rate used by

Wildcat? Perform sensitivity analysis around the inflation rate by changing the rate and observing the effects of the change on NPV. Explain how you made your choices.

REQUIRED

A. Develop a spreadsheet to calculate the NPV of this project, using the nominal rate method.

Be sure to include a data input box at the top of the spreadsheet to allow for sensitivity analysis.

B. Identify a qualitative factor that could potentially override a negative NPV in making the decision to buy this equipment. Explain.

C. Alter the risk premium to perform sensitivity analyses, and answer the following questions:

1. Explain how you decided which values of the risk premium were reasonable to investigate.

2. Describe how changing the risk premium affects the net present value for this project.

3. The new equipment would most likely lower Wildcat’s risk of future lawsuits because of the reduced accident rate. Explain how this factor affects your assessment of the appropriateness of the risk premium.

D. Because Wildcat is uncertain about whether the annual cash savings from the equipment would be $7 million alter the cash savings to perform sensitivity analyses and answer the following questions:

1. Explain how you decided which values of the cash savings were reasonable to investigate.

2. Describe how changing the cash savings affects the net present value for this project.

3. Identify the level of cash savings that results in an NPV of zero.

E. Current inflation is 2%. Given this information, how reasonable is the inflation rate used by

Wildcat? Perform sensitivity analysis around the inflation rate by changing the rate and observing the effects of the change on NPV. Explain how you made your choices.

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