Question

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:

Year	Traditional Equipment	Contemporary Technology
0	$(1,000,000)	$(4,000,000)
1	600,000	200,000
2	400,000	400,000
3	200,000	600,000
4	200,000	800,000
5	200,000	800,000
6	200,000	800,000
7	200,000	1,000,000
8	200,000	2,000,000
9	200,000	2,000,000
10	200,000	2,000,000

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 the final answers to the nearest dollar. If the NPV is negative, enter your answer as a negative value.

	NPV
Traditional equipment	$______
Contemporary technology	$__________

2. Calculate the net present value for each investment using a discount rate of 14 percent. Round intermediate calculations and the final answers to the nearest dollar.

	NPV
Traditional equipment	$___________
Contemporary technology	$_____________

3. Which rate should the company use to compute the net present value?
The 14% cost of capital

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?

$ ___________

Answer 1

Solution:-

1. Calculate the net present value for each investment using a discount rate of 18 percent:-

	NPV
Traditional Equipment	381,460
Contemporary Technology	-440,320

Explanation:-

2. Calculate the net present value for each investment using a discount rate of 14 percent:-

	NPV
Traditional Equipment	548,020
Contemporary Technology	397,120

Explanation:-

4. What is the NPV now:-

191,070

Explanation:-

There may be rounding off error as PV factor are not provided by you.