Activity Instructions

Your assignment for this week is to solve the following case application. There are two questions in this assignment, both with multiple sections. The assignment is worth 90 points, and all questions are equally weighted.

Depreciation, salvage values, net working capital requirements, and tax effects are all included in these cash flows. The CFO also made subjective risk assessments of each project, and he concluded that both projects have risk characteristics that are similar to the firms average project. Allieds WACC is 10%. You must determine whether one or both of the projects should be accepted.

1. You recently went to work for Allied Components Company, a supplier of auto repair parts used in the after-market with products from Daimler AG, Ford, Toyota, and other automakers. Your boss, the chief financial officer (CFO), has just handed you the estimated cash flows for two proposed projects. Project L involves adding a new item to the firms ignition system line; it would take some time to build up the market for this product so that the cash inflows would increase over time. Project S involves an add-on to an existing line, and its cash flows would decrease over time. Both projects have 3 year lives because Allied is planning to introduce entirely new models after 3 years. Here are the net cash flows (in thousands of dollars):

   Expected Net Cash Flows

   Year	Project L	Project S
   0	($200)	($200)
   1	20	140
   2	120	150
   3	170	20

   1. What is the NPV of each project? According to NPV, which project(s) should be accepted if they are independent? Mutually exclusive?
   2. What is the IRR of each project? According to IRR, which project(s) should be accepted if they are independent? Mutually exclusive?
   3. What is the payback period for each project? According to the payback criterion, which project(s) should be accepted if the firms maximum acceptable payback is two years if Projects L and S are independent?
   4. What are the two main disadvantages of discounted payback? Is the payback method useful in capital budgeting decisions? Explain.

1. Colsen Communications is trying to estimate the first-year cash flow (at Year 1) for a proposed project. The assets required for the project were fully depreciated at the time of purchase. The financial staff has collected the following information on the project:
   • Sales revenues: $ 20 million
   • Operating costs: 14 million
   • Interest expense: 2 million
2. The company has a 30% tax rate, and its WACC is 14%. What is the projects cash flow for the first year?

Writing and Submission Requirements

• You must respond to the questions assigned using complete sentences.