ABC Company is considering two projects. The company has funding of $230 million availble to expand its sales distribution. Project A would allow the company to expand into some new but unproven products. Project B would allow the company to expand its existing product line-up although some of the product is aging quickly. The company president wants to minmize risk since the company is running just above break-even and is, therefore, marginally profitable right now. New products have potential as the company has a good reputation for innovation, quality and service. Existing products have expereinced fierce competition of late but customers have been loyal. The required project payback period is maximum 3 years and the required return is 10%.

Project B has the following capital budgeting statistics:

Net present value (NPV) $42.4 Million

Internal rate of return (IRR) 17.1%

Payback period 3 years (Target maximum 3 years)

Profitability index 1.18

Average EBIT $51.2 Million average over 5 years

A. Calculate the same statistics for Project A given the assumptions below (20 marks):

Assumptions:

Project life 5 years

Tax rate 50%

Discount rate (WACC) 10% required return

Interest expense $20 Million a year

Internal rate of return (IRR) 19.6% (given)

Investment $200.0 Million

Depreciation $40.0 Million a year for 5 years

Working capital $30.0 Million but reverses in Year 5

Salvage value Zero (investment assets are worthless in 5 years)

Operating profit (EBIT):

Year 1 $50.0 Million

Year 2 $70.0 Million

Year 3 $70.0 Million

Year 4 $70.0 Million

Year 5 $70.0 Million

B. Explain, which project, is best for the company to select and discuss why