Question: A company is considering two mutually exclusive methods, Alternative 1 and 2, of producing a new product. The relevant data concerning the alternative appear below.
A company is considering two mutually exclusive methods, Alternative 1 and 2, of producing a new product. The relevant data concerning the alternative appear below. At the end of the useful life of whatever equipment is chosen for Alternatives 1 and 2 the product will be discontinued, therefore all net working capital borrowed from the firm will be recouped (returned) to the parent firm. The company's tax rate and the discount rate are provided. Annual depreciation should be calculated using the Straight-line method where the Initial Investment is divided by the expected life of the equipment.
a.Construct the annual proforma project cash flows using the skeleton statement labels below.
b.Calculate the net present value of each alternative.
c.Calculate the benefit-cost ratio for each alternative. Benefit-cost ratio = Sum of the present value of future cash flows/Initial cash outflow.
d.Calculate the internal rate of return for each alternative.
e.Construct an NPV Profile - chart Alternatives 1 and 2 so that the NPV is your Y-Axis and various rates are your X-axis.
f.Use a timeline for the Difference of Cash Flows between Alternative 1 and Alternative 2 to find the crossover point, the point where both projects are exactly equal.
g.Calculate the Equivalent Annuity Benefit for each alternative.
Alt #1
Alt #2
Initial investment
$60,000
$120,000
Net Working Cap. Invest.
5,000
10,000
Annual receipts
50,000
60,000
Annual disbursement
20,000
12,000
Annual depreciation
Project life (years)
4
6
The expected life of Equipment
4
6
Salvage value
$0
$0
Tax rate 35%
Discount rate 9%
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