Jeong Natural Snacks is contemplating an expansion. The finance manager is looking at buying a second machine that would cost $62,000 and last for 10 years, with no disposal value at the end of that time. Jeong expects the increase in cash revenues from the expansion at $28,000 per year, with additional annual cash costs of $18,000. Jeong’s cost of capital is 8%, and the company pays no taxes because of its location in a special economic zone.

Required

1. Calculate the net present value and internal rate of return for this investment.
2. Assume the finance manager of Jeong is unsure about the cash revenues and costs. The revenues could be anywhere from 10% higher to 10% lower than predicted. Assume cash costs are still $18,000 per year. What are NPV and IRR at the high and low points for revenue?
3. The finance manager thinks that costs will vary with revenues, and if the revenues are 10% higher, the costs will be 7% higher. If the revenues are 10% lower, the costs will be 10% lower. Recalculate the NPV and IRR at the high and low revenue points with this new cost information.
4. The finance manager has decided that the company should earn 2% more than the cost of capital on any project. Recalculate the original NPV in requirement 1 using the new discount rate and evaluate the investment opportunity.
5. Discuss how the changes in assumptions have affected the decision to expand.