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	$(1,000,800)	$(4,006,700)
1	591,550	200,200
2	400,200	391,550
3	206,100	609,950
4	206,100	809,950
5	206,100	809,950
6	206,100	809,950
7	206,100	999,600
8	206,100	2,003,800
9	206,100	2,003,800
10	206,100	2,003,800

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	$______?_____ It's not 391,517
Contemporary technology	$_____?_____ It's not -431,049

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	$_____?_____ It's not 561,754
Contemporary technology	$_____?_____ It's not 409,974

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?
$____?______ it's not 193,904

Answer 1

Solution 1:

Computation of NPV - Sweeney Manufacturing
			Traditional Equipment		Contemporary Technology
Particulars	Period	PV Factor (18%)	Amount	Present Value	Amount	Present Value
Cash outflows:
Cost of Equipment	0	1	$1,000,800	$1,000,800	$4,006,700	$4,006,700
Present Value of Cash outflows (A)				$1,000,800		$4,006,700
Cash Inflows
Year 1	1	0.84746	$591,550	$501,314	$200,200	$169,661
Year 2	2	0.71818	$400,200	$287,417	$391,550	$281,205
Year 3	3	0.60863	$206,100	$125,439	$609,950	$371,234
Year 4	4	0.51579	$206,100	$106,304	$809,950	$417,763
Year 5	5	0.43711	$206,100	$90,088	$809,950	$354,037
Year 6	6	0.37043	$206,100	$76,346	$809,950	$300,031
Year 7	7	0.31393	$206,100	$64,700	$999,600	$313,799
Year 8	8	0.26604	$206,100	$54,830	$2,003,800	$533,087
Year 9	9	0.22546	$206,100	$46,466	$2,003,800	$451,769
Year 10	10	0.19106	$206,100	$39,378	$2,003,800	$382,855
Present Value of Cash Inflows (B)				$1,392,283		$3,575,442
Net Present Value (NPV) (B-A)				$391,483		-$431,258

Solution 2:

Computation of NPV - Sweeney Manufacturing
			Traditional Equipment		Contemporary Technology
Particulars	Period	PV Factor (14%)	Amount	Present Value	Amount	Present Value
Cash outflows:
Cost of Equipment	0	1	$1,000,800	$1,000,800	$4,006,700	$4,006,700
Present Value of Cash outflows (A)				$1,000,800		$4,006,700
Cash Inflows
Year 1	1	0.87719	$591,550	$518,904	$200,200	$175,614
Year 2	2	0.76947	$400,200	$307,941	$391,550	$301,285
Year 3	3	0.67497	$206,100	$139,112	$609,950	$411,699
Year 4	4	0.59208	$206,100	$122,028	$809,950	$479,555
Year 5	5	0.51937	$206,100	$107,042	$809,950	$420,663
Year 6	6	0.45559	$206,100	$93,896	$809,950	$369,002
Year 7	7	0.39964	$206,100	$82,365	$999,600	$399,477
Year 8	8	0.35056	$206,100	$72,250	$2,003,800	$702,450
Year 9	9	0.30751	$206,100	$63,377	$2,003,800	$616,184
Year 10	10	0.26974	$206,100	$55,594	$2,003,800	$540,513
Present Value of Cash Inflows (B)				$1,562,509		$4,416,443
Net Present Value (NPV) (B-A)				$561,709		$409,743

Solution 3:

As cost of capital of company is 14% therefore company should use 14% rate to compute net present value.

Solution 4:

Computation of NPV - Sweeney Manufacturing
			Traditional Equipment
Particulars	Period	PV Factor (14%)	Amount	Present Value
Cash outflows:
Cost of Equipment	0	1	$1,000,800	$1,000,800
Present Value of Cash outflows (A)				$1,000,800
Cash Inflows
Year 1	1	0.87719	$591,550	$518,904
Year 2	2	0.76947	$400,200	$307,941
Year 3	3	0.67497	$103,050	$69,556
Year 4	4	0.59208	$103,050	$61,014
Year 5	5	0.51937	$103,050	$53,521
Year 6	6	0.45559	$103,050	$46,948
Year 7	7	0.39964	$103,050	$41,183
Year 8	8	0.35056	$103,050	$36,125
Year 9	9	0.30751	$103,050	$31,689
Year 10	10	0.26974	$103,050	$27,797
Present Value of Cash Inflows (B)				$1,194,677
Net Present Value (NPV) (B-A)				$193,877