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Your team recently went to work for MKA Components Company, a supplier of auto repair parts used in the after-market with products from Daimler
Your team recently went to work for MKA Components Company, a supplier of auto repair parts used in the after-market with products from Daimler AG, Ford, Toyota, and other automakers. Your boss, the chief financial officer (CFO), has just handed your team the estimated cash flows for two proposed projects. Project L involves adding a new item to the firm's ignition system line; it would take some time to build up the market for this product, so the cash inflows would increase over time. Project S involves an add-on to an existing line, and its cash flows would decrease over time. Both projects have 3-year lives because MKA is planning to introduce entirely new models after 3 years. Here are the projects' after-tax cash flows (in millions of dollars): 0 Project L Project S -$100 -$100 1 2 3 $10 $60 $80 $70 $50 $20 Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows. The CFO also made subjective risk assessments of each project, and he concluded that both projects have risk characteristics that are similar to the firm's average project. MKA's Weighted Average Cost of Capital (WACC) is 10%. Your team must determine whether one or both of the projects should be accepted. Answer the following questions. Q1: Use the cash flows and WACC above for calculation. (5 Pts) a) Using NPV method, which project(s) should be accepted if they are mutually exclusive? b) Would the NPVs change if the WACC changed to 7% in year 1, 10% in year 2 and 13% in Year 3? Explain. Q2: a) Calculate each project's IRR? According to IRR, which project(s) should be accepted if they are Mutually exclusive? (5 Pts) b) State your decision assuming the WACC changed to i) 16% and ii) 25%? Explain. Q3: Draw NPV profiles for Projects L and S. At what discount rate do the profiles cross (i.e. NPV of both the projects is equal)? Look at your NPV profile graph without referring to the actual NPVs and IRRs. Which project(s) should be accepted if they are mutually exclusive? Explain. (5 Pts) Q4: Find the paybacks* for Projects L and S. According to the payback criterion, which project(s) should be accepted if the firm's maximum acceptable payback is 2 years, if Projects L and S are independent? (5 Pts)
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