XYZ Company aims to construct a high-technology computer-based machinery system in order to increase the efficiency of its production. The company has 2 offers from 2 different technology companies and can only choose one of them. The offers are as following:

PearTech Co.: The new computer-based system requires an initial investment of $900,000, but it will increase the companys sales by $500,000 a year for each of the next 4 years. Moreover, the system also requires an annual operating cost, which is expected to be 50% of its sales. The working capital requirement will be $40,000 at the start of the project (t=0) and expected to decrease by $4,000 each year. Lastly, it is assumed that the new system will be depreciated over 4 years to a salvage value of zero using straight-line depreciation method.

PeachTech Co.: The new computer-based system requires an initial investment of $1,000,000, but it will generate $700,000 of sales in year 1 and sales are expected to decrease by $50,000 each year. In addition, the system will cost $300,000 per year to operate. From the start of the project (t=0) the working capital required in each year is expected to be 5% of sales in the following year. Lastly, the new system will be depreciated on a straight-line basis over its 5-year life to a salvage value of $300,000.

a. If the tax rate is 40% what are the cash flows of these projects in each year?

b. If the opportunity cost of capital is 10%, what are the NPVs of these projects? Which project will you choose according to the NPV criteria?

c. If you apply the payback period criteria, which project will you choose?

d. If you apply the profitability index criteria, which project will you choose?

e. Based on your answers in (b) through (d), which project will you finally choose?