Comprehensive Problem Three

Evaluating Project Alternatives

You are employed as an analyst for a financial management consulting firm. You are

asked to evaluate two capital project proposals from two clients. Please prepare a $1$ to $1-$

$(1)/(2)$ page type written memorandum evaluating Capital Investment Options I and II below.

The evaluation must be supported by your analysis and calculations. The memorandum

must also include a brief explanation of the concepts applied and how they are used in the

decision making process. Do not write about the calculations. Address the memorandum

to Mr$.$ Vericker in the standard format. $($Use full sentences in a paragraph format and

attach a separate sheet with your calculations.$)$

Capital Investment Option I. Winthrop Manufacturing, Inc is considering two

investments, both of which cost $$35,000,000.$ The cost of capital $($WACC$)$ is $10\%$ for the

company. The projects are mutually exclusive. The cash flows are as follows:

Year Project A Project B

$1$ $$42,000,000$ $$30,000,000$

$2$ $$28,000,000$ $$25,000,000$

$3$ $$21,000,000$ $$56,000,000$

Which of the two projects should be chosen based upon the:

$1.$ payback method.

$2.$ net present value method

Should a firm normally have more confidence in the payback method or the net present

value method?

Capital Investment Option II$.$ Another company, Augusta Cleaning Supplies, Inc. is

considering the purchase of a warehouse automated picking system at a cost of

$$2,132,000,$ delivered and installed. The machine is forecasted to provide $$300,000$ per

year in cash flow for nine years. The company$$s cost of capital $($WACC$)$ is $11\%.$ Using

the Internal Rate of Return Method, evaluate this investment and state whether or not

the investment should be undertaken and why.