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The Mulligan company, a manufacturer of electrical parts, is evaluating two mutually exclusive projects A&B. The projects are somewhat riskier than the usual projects the

The Mulligan company, a manufacturer of electrical parts, is evaluating two mutually exclusive projects A&B. The projects are somewhat riskier than the usual projects the firm undertakes; management uses the subjective approach and decided to apply an adjustment factor of +2% to the cost of capital for both projects.

The companys a marginal tax rate is 21%, and cost of capital is 11%, evaluate the following proposals.

Project A is a six-year project that requires an initial fixed asset investment of $3 million. The fixed asset falls into the seven-year MACRS class. Based on $20 per unit sale price, the project is estimated to generate $2,050,000 in sales during its first year, with production costs of $950,000. Sales and costs are expected to grow at 3% annually. The project requires a single initial investment in net working capital of $285,000 which is expected to be recovered in six years when the project is terminated. The fixed asset will have a market value of $225,000 at the end of its six years life.

Project B is also a six-year project that requires an initial fixed asset investment of $1.9 million that falls into the seven-year MACRS class. The fixed asset will also require an additional $100,000 in shipping and installation. The marketing firm predicts that first year sales related to the project will be 62,500 units, at a price of $16 per unit, and grow at an annual rate of 4%.

Operating costs related to the project are predicted to be 22% of sales. The project will also require an initial net working capital investment of $150,000 which is expected to be recovered at the end of six years. The asset is expected to have a market value of $22,000 at the end of the six years when the project is terminated.

The MACRS tax rates are given below:

Year

3

5

7

1

33.33%

20.00%

14.29%

2

44.44%

32.00%

24.49%

3

14.81%

19.20%

17.49%

4

7.41%

11.52%

12.49%

5

11.52%

8.92%

6

5.76%

8.92%

7

8.92%

8

4.46%

  1. Calculate project As cash flows for years 0-6
  2. Calculate NPV, IRR and PI for project A
  3. Calculate project Bs cash flows for year 0-6
  4. Calculate NPV, IRR and PI for project B
  5. Which project should be accepted if any and why?
  6. What is the exact NPV profiles crossover rate (incremental IRR)? And what is the relevance of this rate?

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