RWE Enterprises Ltd is a small manufacturing firm located in New Plymouth. The firm is engaged in the manufacture and sale of feed supplements used by cattle raisers. The product has molasses base but is supplemented with minerals and vitamins that are generally thought to be essential to the health and growth of beef cattle. The final product is put in 75-kg or 100-kg tubs that are then made available for the cattle to lick as desired. The material in the tub becomes very hard, which limits the animals consumption.

The firm has been running a single production line for the past five years and is considering the addition of a new line. The addition would expand the firms capacity by almost 120% because the newer equipment requires a shorter downtime between batches. After each production run, the boiler used to prepare the molasses for the additional minerals and vitamins must be heated to 85 degrees Celsius and then must be cooled before beginning the next batch. The total production run entails about four hours and the cool-down period is two hours (during which time the whole process comes to a halt). Using two production lines increases the overall efficiency of the operation because workers from the line that is cooling can be moved to the other line to support the canning process involved in filling the feed tubs.

The equipment for the second production line will cost $3 million to purchase and install and will have an estimated after-tax scrap value of $200,000. Furthermore, at the end of five years, the production line will have to be refurbished at an estimated cost of $2 million. RWEs management estimates that the new production line will add $700,000 per year in after tax cash flows to the firm.

Required:

a) If RWE uses a 10% discount factor to evaluate investments of this type, what is the net present value of the project? What does this NPV indicate about the potential value RWE might create by purchasing the new production line? (6 marks)

b) Calculate the internal rate of return and profitability index for the proposed investment. What do these two measures tell you about the projects viability? (6 marks)

c) Calculate the payback and discounted payback periods for the proposed investment. Interpret your findings. (4 marks)

d) What is the rationale of using MIRR as opposed to IRR decision criteria? Describe the fundamental shortcoming of the MIRR method (5 marks)