NPV $/$ IRR Problems

Kraemer Company is trying to reduce its cost structure in an effort to boost profits. It is looking at

automating parts of its production process. It is evaluating two different pieces of equipment to accomplish

the cost reductions. Below are the free cash flow estimates associated with the two projects.

WACC $9\%$ Equip A Cash Flows

Today Year $1$ Year $2$ Year $3$ Year $4$

Cost of equipment $$(100,000)$

Shipping & handling $$(5,000)$

Start $-$ up expenses $$(15,000)$

Total Investment $$(120,000)$

Labor savings $($after tax$)$ $$15,000$ $$35,000$ $$50,000$ $$60,000$

Salvage value $($after tax$)$ $$-$ $$-$ $$-$ $$5,000$

Total Savings $$15,000$ $$35,000$ $$50,000$ $$65,000$

NPV IRR Payback

MIRR PI

Equip B Cash Flows

WACC $9\%$ Today Year $1$ Year $2$ Year $3$ Year $4$

Cost of equipment $$(120,000)$

Shipping & handling $$(5,000)$

Start $-$ up expenses $$(5,000)$

Total Investment $$(130,000)$

Labor savings $($after tax$)$ $$30,000$ $$40,000$ $$50,000$ $$50,000$

Salvage value $($after tax$)$ $$-$ $$-$ $$-$ $$10,000$

Total Savings $$30,000$ $$40,000$ $$50,000$ $$60,000$

NPV IRR Payback

MIRR PI

$1)$ Explain in simple business terms what NPV means to your CEO.

$2)$ What are the two major drawbacks to using IRR?

$3)$ What is the difference between IRR and MIRR?

$4)$ Explain what the Profitability Index is and how it should be used.

$5)$ Explain why Payback sucks as a value metric.

$6)$ How would the type of financing impact NPV$?$