Ch 11: End-of-Chapter Problems - The Basics of Capital Budgeting Kim Inc, munt install a new air conditioning unit in its main plant. Kim must install one or the other of the units; otherwise, the highly profitable plant would have to shut down. Two units are available, HCC and LCC (for high and low capital costs, respectively). HOC has a high capital cost but relatively low operating costs, while LCC has a low capital cost but higher operating costs because it uses more electricity. The costs of the units are shown here. Kim's WACC is 5%. 2 0 5 HCC LOC $610,000 -$55,000 -355,000 -$55,000 -$55,000 - $55.000 -$110,000 -$175,000 -$175,000 -$175,000 -$175,000 $175,000 a. Which unit would you recommend 1. Since we are examining costs, the unit chosen would be the one that had the lower NPV of costs. Since LCC's NPV of costs is lower than HCCS, LCC would be chosen 11. Since we are examining costs, the unit chosen would be the one that had the lower NPV of costs. Since HOC's NPV of conts is lower than LCC, HCC would be chosen III. Sinco all of the cash flows are negative, the IRR's will be negative and we do not accept any project that has a negative RR. TV. Since all of the cash flows are negative, the NPV' cannot be calculated and an alternative method must be employed. V. Since all of the cash flows are negative, the NPV's will be negative and we do not accept any project that has a negative NPV. b. If Kim's controller wanted to know the tru of the two projects, what would you tell him? 1. The IRR cannot be calculated because the cash flows are all one sign. A change of sign would be needed in order to calculate the IRR. 11: The tre cannot be calculated because the cash flows are in the form of an annuity III. The IRR of each project will be positive at a lower WACC. TV There are multiple IRR's for each project The IRR of each project is negative and therefore not useful for decision making If the WACC rose to 10 wound this affect your recommendation www Kung Wouc h 11: End-of-Chapter Problems - The Basics of Capital Budgeting 11. The IRR cannot be calculated because the cash flows are in the form of an annuity. m. The IRR of each project will be positive at a lower WACC. TV. There are multiple IRR's for each project V. The IRR of each project is negative and therefore not useful for decision-makino, Select c. If the WACC rose to 10% would this affect your recommendation? I. When the WACC increases to 10%, the IRR for LCC is greater than the IRR for HCC) LCC would be chosen II. When the WACC increases to 10%, the tre for HCC is greater than the IRR for LCC, HCC would be chosen 111. Since all of the cash flows are negative, the NPV's will be negative and we do not accept any project that has a negative NPV. 10. When the WACC increases to 10%, the NPV of costs are now lower for LCC than HCC V. When the WACC increases to 10%. the NPV of costs are now lower for Hoc than LCC. Why do you think this result occurred? 1. The reason is that when you discount at a higher rate you are making negative CFs higher thus improving the IRR. II. The reason is that when you discount at a higher rate you are making negative CFs higher thus improving the NPV. II. The reason is that when you discount at a higher rate you are making negative CFs higher and this lowers the NPV 16. The reason is that when you discount at a higher rate you are making negative che smaller and this towers the NPV V Thermion is that when you discount at a higher rate you are making negative CFs smaller thus improving the NV
