Description

You recently went to work for Allied Components Company, a supplier of auto repair parts used in the after-market with products from Daimler, Chrysler, Ford, 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 firm's ignition system line; it would take some time to build up the market for this product, so 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 projects' net cash flows (in thousands of dollars):

Year	Project L	Project S
0 (Initial Investment)	-$100	-$100
1	$10	$70
2	$60	$50
3	$80	$20

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 firm's average project. Allied'scost of capital/discount rate (r) is 10%.

Task 1:Explain how the following terms are used in loss control investment decisions.

a.Time value of money

b.Internal rate of return

Task 2:Calculate Each Project's NPV using the NPV formula. If you are required to accept one project out of these two projects, which one should you accept and why?

Task 3:Calculate Each Project's IRR using MS Excel. If you are required to accept one project out of these two projects, which one should you accept and why?

Task 4: "NPV method is better than IRR".- Justify.