Scenario One:

Uncle Sams Manufacturing Co. produces metal stamping machines. After five years, the once successful line is no longer selling well, so the company is considering production of an improved line of machines incorporating new green technology. This can be done by buying needed production equipment. There is a six-month manufacturing, delivery, setup, and training delay before the equipment will be ready for production. The company wants to start producing the new line of machines in January next year. Two options are available lease or buy.

Buy Option The entire purchase price of the production equipment is $800K and is due at the time of the order. The cost of capital for this purchase is 7%. Assume: (1) the equipment has no residual value at the end of the fifth year and (2) there are no taxes.

Lease Option The total lease cost is $700K. A $75K deposit is due at the time of the order. The remaining portion of the first years lease payment ($65K) is due in January next year. The other four annual lease payments ($140K each) are due in January of production years 2, 3, 4, and 5. The cost of capital for leasing is 16%. Assume no taxes.

Revenue from sales of the new line of metal stamping machines is expected to be:

Year 1 - $610,000

Year 2 $500,000

Year 3 $301,000

Year 4 $200,000

Year 5 $101,000

1. Calculate the

A. net present value of both the new purchase option and

B. the lease option. Show all work.

C. Determine the best option for Jones and justify your answer.

2. You used the Excel NPV function with the correct discount rates to calculate NPV and you got the following values: Buy $632,812.27; Lease - $672,483.77. What did you do wrong?

3. Calculate IRR for

A. Purchase option

B. Lease option.

4. Assuming projected inflows and outflows are accurate, under what conditions can Uncle Sams expect to see a return equal to IRR? Is this realistic?

Other Related Questions:

5. Based on the NPV profile shown below, what is the approximate internal rate of return (IRR)?

6. You work for a company whose primary long term financial goal is to undertake projects that maximize company value. You have been asked to provide a recommendation with respect to ranking three mutually exclusive projects. The first project has a NPV of $200K and an IRR of 10%; the second has a NPV of $180K and an IRR of $12%; the third has a NPV of 220K and an IRR of 9%. How would you rank the projects? Explain.

7. Using appropriate financial analysis tools (e.g., NPV, IRR, and payback analyses), your company has already identified several independent projects that will add value to the company. Unfortunately, the company has an insufficient capital budget to undertake all of the projects and management has declined additional debt or equity financing efforts to increase the capital budget. What recommendation would you make for selecting the appropriate projects

NPV vs. Hurdle Rate (%) 30,000 25,000 20,000 15,000 10,000 5,000 0 -5,000 10,000 15,000 20,000 25,000 2 4 5 6 10 NPV vs. Hurdle Rate (%) 30,000 25,000 20,000 15,000 10,000 5,000 0 -5,000 10,000 15,000 20,000 25,000 2 4 5 6 10