Please refer to earlier Project threads for context. This is for Steps 7, 8 and 9 which should be submitted by the end of Week 11.
Meanwhile, a colleague of yours from IT needs help justifying the purchase of software for your department and asks for your help in justifying the investment. You agree to help because you know that this particular software will help you generate the information you need in your board presentation.
Scenario Steps to Completion
7. The company can purchase new planning software for $3,600. The software (asset) has a two-year life, will produce a savings of $600 in the first year and $4,200 in the second year.
The discount rate is 15%. Calculate the project’s payback and discounted payback period assuming steady cash flows. Also calculate the project’s NPV and IRR. Should the project be funded?
In light of the previous information provided, is the 15% discount rate justified. Explain your answer.
Concept Check: Payback analysis is the first step in project evaluation. The calculation enables you to understand if you can simply cover the investment within a certain time period. When doing Discounted Payback analysis or NPV analysis, a discounting rate is used to reduce future cash flows to a present value. The discount rate can be determined in many ways; existing cost of capital, projected cost of capital, desired return rate, etc as long as you justify what you wish to use for discounting cash flows and are consistent in your application evaluation will be easier.
Helpful Hint: IRR is discovered when you calculate an NPV where the result is zero (or as close to zero as you can get); this is an iterative process of adjusting the discount rate until you arrive at zero for an NPV. The best thing to do is first calculate NPV and see how far away from zero you are â€“ you can then increase or decrease the discount rate until your NPV = zero.
Sue has another vexing problem she has been encountering with regard to capital investments. She has competing investments and has looked at them from several different perspectives and would like your input.
Scenario Steps to Completion
8. Two of the companyâ€™s projects A and B have the same expected lives and initial cash outflows. However, one project’s cash flows are larger in the early years, while the other project has larger cash flows in the later years. The two NPV profiles are given below:
Which of the following statements is most correct?
Explain and support your position.
Concept Check: NPV profile is the result of mapping the relationship between an investmentâ€™s NPV and various discount rates. We begin at the r of zero on the Y axis.
Helpful Hint: It may help to place some numbers on the lines beginning with known variables.
9.) Sue has asked you to analyze the companyâ€™s glass division which has a cost of capital equal to 10%. If the following projects are mutually exclusive, and you only have the information that is provided, which should you accept?
Justify your answer. What does the condition â€œmutually exclusiveâ€ mean? Why would the Divisionâ€™s cost of capital be different than the companyâ€™s overall weighted cost of capital calculated in task 6?
Concept Check: Every organization is faced with multiple opportunities and limited resources. Management must develop systems to logically and impartially examine these options and allocate capital and other resources for the best outcome overall so the organization can expand within the limits of their mission.
Helpful Hint: Many financial models and rules are established to help managers determine best resource allocations. Just like any system, the variables or models can be manipulated to determine an outcome. There should be more than one way to analyze different opportunities and the variables used to measure efficiency need to be constantly monitored for relevancy and accuracy.
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