Question

AZM Corporation is deciding between the introduction of two new automobiles: a traditional gasoline-powered model, or a hydrogen fuel-cell model.   Incremental cash flows in millions of dollars, to be received at the end of each period, are estimated to be:

Year	0	1	2	3	4	5
Gas-Powered	-540	320	240	160	40	0
Fuel Cell	-650	40	80	160	300	600

1. Compute each project’s payback period.

2. What is each project’s internal rate of return?

3. Compute each project’s net present value, assuming that the appropriate discount rate is 10% per year.

4. Assuming AZM’s goal is to maximize firm value, which project should be taken? Support your answer, including a short statement of which evaluation criterion was most relevant, which were less relevant, and why.   

5. Compute each projects NPV again, assuming a discount rate of 14% per year.   Does this change your recommendation? Explain the intuition.  

Answer 1

a. The payback period of Gas powered is :

CF0 = ($540)

CF1 = $320

CF2= $240

CF3= $160

CF4= $40

CF5= 0

So, the payback period is :

= 1 + ($540 - $320) / $240

= 1.916 Years

Similarly, the payback for project B is :

= 4 + $70/ $600

= 4.116 Years

a. The NPV of Project A is :

= ($540) + $320/1.1^1 + $240/1.1^2 + $160/1.1^3 + $40/1.1^4

= $96.7871

Similarly,

NPV of project B is : $150.1465

a.For maximizing the value of the firm we would use Project B as it has a higher NPV so it is more relevant and Project A is less relevant.

At discount rate of 14%,

NPV of project A is : $57.0526

NPV of project B is : $43.8858

a. Yes, this has changed our recommendation from Project B to Project A. The intuition is, as Project B has higher cash flows at the end and lower cash flows in the beginning opposite to that of Project A, changes in the discount rate leads to a GREATER decrease in the NPV.