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NEW QUESTION: 1
KGraphix, a small, privately owned publishing company, plans to upgrade its printing process by purchasing either a high-speed color laser printer or a webpress (a high speed color printing machine).
Incremental cash flow information for each piece of equipment is as follows:
Assuming that the company's weighted average cost of capital (WACC) is 13 percent, which of the following statements is most correct? KGraphix should purchase the:
A. color laser printer because it has the highest equivalent annual annuity.
B. webpress because it has the longest life and the highest net present value (NPV).
C. webpress because its net present value (NPV) of $9,939 is greater than the color laser printer's NPV of
$7,223.
D. color laser printer because its Internal rate of return (IRR) is higher than that of the webpress.
Answer: A
Explanation:
Explanation/Reference:
Explanation:
Here, we have two projects with unequal lives, so we have to adjust the cash flow. We can either adjust the cash flows of the shorter-term project to match the life of the longer-term project (adjusted NPV), or we can use the equivalent annual annuity (EAA) approach. The answer given is most correct because the project with the highest EAA will have the highest adjusted NPV, and the color laser printer has the highest EAA (and adjusted NPV). (See table below.) The statement, "KGraphix should purchase the webpress because its NPV of $9,939 is greater than the color laser printer's NPV of $7,223," calculates NPV only using the given lives (or unadjusted NPV).
Unadjusted NPV is not the best criterion to use for deciding between mutually exclusive projects with unequal lives. Although the color laser printer has an IRR higher than that of the webpress, IRR is also not the best criterion to use for mutually exclusive projects with unequal lives Quantitatively: (all amounts are in $ unless indicated otherwise):
Notes:1Repeats color laser project beginning in year 3; year 3 cash flow equals the net initial investment cost of $40,000 and $20,000 inflow from the last year of the "first" printer.
Following are examples of how to use financial calculator to solve this problem. (Note, the example is for the unadjusted NPV, IRR, and EAA of the color laser printer. Use a similar methodology to determine the NPV, IRR, and EVA for the other cash flows streams.
Note:1Negative sign is for calculator functionality, not to signify a negative amount
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