USE ONLY EXCEL FUNCTIONS =YIELD(...), =NPV(...) and =IRR(...)

Find NPV and IRR

Let's recall the prior exercises in Ch. 10, and see what the WACC shall be used for.

In HW for Chapter 10, Part B Caterpillar exercises, we find that to finance capital investment projects, using debt capital alone will cost relatively less [particularly after multiplying yield-to-maturity Rd with (1 - Tax rate), with tax deduction benefit on corporate debt interest expenses] but will increase the bankruptcy risk; while using equity capital alone will lower the bankruptcy risk but the cost of equity could be higher compared with the after-tax cost of debt capital. So, the best way to finance an investment project while keeping the firm's growth sustainable is to "use some debt, and use some equity, therefore keeping the existing debt-equity ratio constant and not off-balance." As a result, the best required return (i.e., discount rate, or cost of capital) for an investment project is the firm's WACC, which is the weighted average of debt and equity capital!

Assume CAT wants to consider investing on the computer order-entry system described in Chapter 10, Ex. 14. The discount rate for NPV and IRR analysis shall then be CAT's WACC.

WACC = 17.29%

Ex. 14

Your firm is contemplating the purchase of a new $720,000 computer-based order entry system. The system and will be depreciated straight line to zero over it's five-year life. It will be worth $75,000 at the end of that time. You will save $260,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $110,000 (this is a one-time reduction). If the tax rate is 35%, what is the IRR for this project?

WACC = 17.29%

1) Based on the IRR analysis, shall CAT purchase the order entry system or not?

2) Based on the NPV analysis, shall CAT purchase the system or not?

3) What would be the resulting NPV amount being added by this system project to CAT investors?