1. Are the book rates of return reported in Tables 5.1 and 5.2 useful inputs for the capital investment decision?

2. Calculate NPV and IRR for each process. What is your recommendation? Be ready to explain to the CFO.

Later that afternoon, Vegetron's CFO bursts into your office in a state of anxious confusion. The problem, he explains, is a last-minute proposal for a change in the design of the fermentation tanks that Vegetron will build to extract hydrated zirconium from a stockpile of powdered ore. The CFO has brought a printout (Table 5.1) of the forecasted revenues, costs, income, and book rates of return for the standard, low-temperature design. Vegetron's engineers have just proposed an alternative high-temperature design that will extract most of the hydrated zirconium over a shorter period, five instead of seven years. The forecasts for the high-temperature method are given in Table 5.2.

TABLE 5.1

a Rounded. Straight-line depreciation over seven years is 400/7 = 57.14, or $57,140 per year.
b Capital investment is $400,000 in year 0.
TABLE 5.2

a Straight-line depreciation over five years is 400/5 = 80, or $80,000 per year.
b Capital investment is $400,000 in year 0.

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Year 140 140 140 140 140 140 140 1. Revenue 2. Operating costs 3 Depreciation 4. Net income 5. Start-of-year book value400343 286 6. Book rate of return (4+5 57 28 555 28 28 57 49.1% 28 28 28 28 229 114 7% 8.2% 9.8% 12.2% 16.4% 24.6% Year 1. Revenue 2. Operating costs 180 70 180 70 180 70 180 70 180 70 Depreciation 4. Net income 5. Start-of-year book value 6. Book rate of return (4+5 30 400 30 320 30 240 30 30 80 37.5% 160 7.5% 9.4% 12.5% 18.75%