Problem 19.25 (Algorithmic) Discount Rates, Quality, Market Share, Contemporary
ID: 2416771 • Letter: P
Question
Problem 19.25 (Algorithmic)
Discount Rates, Quality, Market Share, Contemporary Manufacturing Environment
Sweeney Manufacturing has a plant where the equipment is essentially worn out. The equipment must be replaced, and Sweeney is considering two competing investment alternatives. The first alternative would replace the worn-out equipment with traditional production equipment; the second alternative uses contemporary technology and has computer-aided design and manufacturing capabilities. The investment and after-tax operating cash flows for each alternative are as follows:
The company uses a discount rate of 18 percent for all of its investments. The company's cost of capital is 14 percent.
The present value tables provided in Exhibit 19B.1 and Exhibit 19B.2 must be used to solve the following problems.
Required:
1. Calculate the net present value for each investment using a discount rate of 18 percent. Round intermediate calculations and your final answer to the nearest dollar. If the NPV is negative, enter your answer as a negative value.
2. Calculate the net present value for each investment using a discount rate of 14 percent. Round intermediate calculations and the final answer to the nearest dollar.
3. Which rate should the company use to compute the net present value?
- Select your answer -The 18% discount rateThe 14% cost of capitalA rate higher than 18%A rate lower than 14%Item 5
4. Now, assume that if the traditional equipment is purchased, the competitive position of the firm will deteriorate because of lower quality (relative to competitors who did automate). Marketing estimates that the loss in market share will decrease the projected net cash inflows by 50 percent for Years 3–10. Recalculate the NPV of the traditional equipment given this outcome using a discount rate of 14 percent. Round intermediate calculations and your final answer to the nearest dollar.
What is the NPV now?
$
What is the decision now?
- Select your answer -Contemporary technology is preferredTraditional equipment is preferred
Year Traditional
Equipment Contemporary
Technology 0 $(998,050) $(4,005,200) 1 607,300 206,200 2 396,300 397,700 3 207,750 594,750 4 207,750 809,900 5 207,750 809,900 6 207,750 809,900 7 207,750 992,550 8 207,750 1,999,200 9 207,750 1,999,200 10 207,750 1,999,200
Explanation / Answer
Year Traditional Contemporary Present Value Factor @ 18% Present Value Present Value Factor @ 14% Present Value Revised Cash Flows Present Value Factor @ 14% Present Value Equipment Technology Traditional Contemporary Traditional Contemporary Traditional Contemporary Traditional Contemporary 0 (998,050) (4,005,200) 1.00 (998,050) (4,005,200) 1.00 (998,050) (4,005,200) (998,050) (4,005,200) 1.00 (998,050) (4,005,200) 1 607,300 206,200 0.85 514,661 174,746 0.88 532,719 180,877 607,300 206,200 0.88 532,719 180,877 2 396,300 397,700 0.72 284,616 285,622 0.77 304,940 306,017 396,300 397,700 0.77 304,940 306,017 3 207,750 594,750 0.61 126,443 361,983 0.67 140,225 401,439 103,875 297,375 0.67 70,113 200,720 4 207,750 809,900 0.52 107,155 417,737 0.59 123,005 479,526 103,875 404,950 0.59 61,502 239,763 5 207,750 809,900 0.44 90,809 354,015 0.52 107,899 420,637 103,875 404,950 0.52 53,949 210,318 6 207,750 809,900 0.37 76,957 300,013 0.46 94,648 368,980 103,875 404,950 0.46 47,324 184,490 7 207,750 992,550 0.31 65,218 311,586 0.40 83,025 396,660 103,875 496,275 0.40 41,512 198,330 8 207,750 1,999,200 0.27 55,269 531,863 0.35 72,829 700,838 103,875 999,600 0.35 36,414 350,419 9 207,750 1,999,200 0.23 46,838 450,732 0.31 63,885 614,770 103,875 999,600 0.31 31,942 307,385 10 207,750 1,999,200 0.19 39,694 381,976 0.27 56,039 539,272 103,875 999,600 0.27 28,020 269,636 NPV 409,612 (434,927) 581,164 403,815 210,386 (1,557,245) 1) NPV at 18% is 409,612, -434,927 2) NPV at 18% is 581,164, 403,815 3) Company should use Cost of Capital not the Discount Rate for NPV Caluclation 14% Cost of Capital 4) NPV at 14% is 210,386, -1,557,245