Question
Smith Machining Corp. is a small business considering investing in one of 2 new product production lines. However, they can only afford to do one
Smith Machining Corp. is a small business considering investing in one of 2 new product production lines. However, they can only afford to do one of the projects. The development and implementation of either project will take a year and the initial cash outlay will be $1,500,000 if they take a traditional bank loan at 10%. If they pursue a Small Business Association (SBA) guaranteed loan through their bank, the rate on the loan will be 7% however, they will need to pay an up-front fee of 10% of the net proceeds of their loan, which can be added to the loan. The projects have the following projected net cash flows:
| Year | Project A | Project B |
| 1 | $ 250,000 | $ 100,000 |
| 2 | $ 250,000 | $ 100,000 |
| 3 | $ 250,000 | $ 100,000 |
| 4 | $ 500,000 | $ 100,000 |
| 5 | $ 500,000 | $ 100,000 |
| 6 | $ 250,000 | $ 400,000 |
| 7 | $ 100,000 | $ 750,000 |
| 8 | $ 50,000 | $ 750,000 |
| 9 | $ 50,000 | $ 1,000,000 |
- Calculate and show the NPV of each project at the 10% rate
- Calculate and show the NPV of each project at the 7% SBA loan rate
- Which project would you choose, A or B and why?
- Does the SBA loan improve the result and would you recommend getting the SBA loan even with the added 10% cost? Why or why not?
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