Question

# Consider two mutually exclusive R&D projects that Savage Tech is considering. Assume the discount rate for...

Consider two mutually exclusive R&D projects that Savage Tech is considering. Assume the discount rate for both projects is 13 percent.

 Project A: Server CPU .13 micron processing project By shrinking the die size to .13 micron, the company will be able to offer server CPU chips with lower power consumption and heat generation, meaning faster CPUs.
 Project B: New telecom chip project Entry into this industry will require introduction of a new chip for cell phones. The know-how will require a large amount of up-front capital, but success of the project will lead to large cash flows later on.
 Year Project A Project B 0 –\$ -715,000 –\$ -921,000 1 342,000 257,000 2 358,000 363,000 3 256,000 362,000 4 181,000 413,000 5 122,000 498,000

Complete the following table: (Do not round intermediate calculations. Enter the IRR as a percent. Round your profitability index (PI) answers to 3 decimal places, e.g., 32.161, and other answers to 2 decimal places, e.g., 32.16.)

 Project A Project B NPV \$ \$ IRR % % PI

What is the incremental IRR of investing in the larger project? (Do not round intermediate calculations. Enter your answer as a percent and round your answer to 2 decimal places, e.g., 32.16.)

Incremental IRR   _______%

 Year Project A PV @ 13% 0 -715000 -715,000.00 1 342000 302,654.87 2 358000 280,366.51 3 256000 177,420.84 4 181000 111,010.69 5 122000 66,216.71

NPV   222,670.62
IRR   27.639%
PI = Present value of Cash flow / Initail Investment

= 937669.62 / 715000 = 1.311

 Year Project B PV @ 13% 0 -921,000.00 -921,000.00 1 257,000.00 227,433.63 2 363,000.00 284,282.25 3 362,000.00 250,884.16 4 413,000.00 253,300.63 5 498,000.00 270,294.45

NPV   365,195.12
IRR   26.639%
PI = 1,286,195.12 / 921,000 = 1.396

 Year Project A Project B Incremental Cash Flow 0 -715000 -921,000.00 -206,000.00 1 342000 257,000.00 -85,000.00 2 358000 363,000.00 5,000.00 3 256000 362,000.00 106,000.00 4 181000 413,000.00 232,000.00 5 122000 498,000.00 376,000.00

Incremental IRR = 25.1953