1.SHOULD THE $100,000 THAT WAS SPENT TO REHABILITATE THE PLANT BE INCLUDED IN THE ANALYSIS? EXPLAIN.
The $100,000 is a cost already occurred in the past and it was decided on a stand-alone basis. The plant would have been rehabilitated regardless of what would happen with the project, just to protect the company's property. This sunk cost should no way be included in the analysis. Of course the case would have been different if the plant hadn't been rehabilitated and its rehabilitation was decided now for the causes of the project
2. SUPPOSE ANOTHER CITRUS PRODUCER HAD EXPRESSED AN INTEREST IN LEASING THE LITE ORANGE JUICE PRODUCTION SITE FOR $25,000 A YEAR. IF THIS WERE TRUE (IN FACT, IT WAS NOT), HOW WOULD THAT INFORMATION BE INCORPORATED INTO THE ANALYSIS?
This information would cause only a slight change in the decision-making process. More specific we would not recommend realizing the plan if the average net profit per year (including the cost of capital) will be less than or equal to $25,000 which in fact can also be achieved with no risk at all. In order to recommend realizing the project we should either be certain that our profit will be higher than our opportunity cost ($25,000), or have no better alternative to invest the company's capital. Of course the above are valid only if there is no cannibalization effect to our sales from the other's producer's activities. In this case if we accept his proposal and we assume this agreement lasts 4 years and the rent is being paid at the end of each period we have a NPV of 79,246 , which is greater than the NPV of our project which is 23,720. So assuming equal life of the projects and no other side-effect we would prefer to rent the site.
PVIF(10%,1)( 25,000) = 22,727
PVIF(10%,2)( 25,000) = 20,661
PVIF(10%,3)( 25,000) = 18,783
PVIF(10%,4)( 25,000) = 17,075
NPV = 79,246
3. THE SECOND CAPITAL BUDGETING DECISION WHICH LILI AND BRENT WERE ASKED TO ANALYZE INVOLVES CHOOSING BETWEEN TWO MUTUALLY EXCLUSIVE PROJECTS, S AND L, WHOSE CASH FLOWS ARE SET FORTH AS FOLLOWS:
EXPECTED NET CASH FLOW
BOTH OF THESE PROJECTS ARE IN INDIAN RIVER'S MAIN LINE OF BUSINESS, ORANGE JUICE, AND THE INVESTMENT WHICH IS CHOSEN IS EXPECTE TO BE REPEATED INDEFINITELY INTO THE FUTURE. ALSO, EACH PROJECT IS OF AVERAGE RISK, HENCE IS ASSIGNED THE 10% CORPORATE COST OF CAPITAL.
A. WHAT IS EACH PROJECT'S SINGLE-CYCLE NPV? NOW APPLY THE REPLACEMENT CHAIN APPROACH AND THEN REPEAT THE ANALYSIS USING THE EQUIVALENT ANNUAL ANNUITY APPROACH. WHICH PROJECT SHOULD BE CHOSEN, S OR L? WHY?
PROJECT S- CYCLE
PVIF(10%,1)(60,000) = 54,545
PVIF(10%,2)(60,000) = 49,587
NPVS-CYCLE = 4,132
PROJECT L - CYCLE
PVIF(10%,1)(33,500) = 30,455
PVIF(10%,2)(33,500) = 27,686
PVIF(10%,3)(33,500) = 25,169
PVIF(10%,4)(33,500) = 22,881
NPVL-CYCLE = 6,191
REPLACEMENT CHAIN :
NPVS = NPVS-cycle + NPVS-cycle * PVIF(10%,2) =
= 4,132 + 4,132 * 0.826 =
NPVS = 7,543
EQUIVALENT ANNUAL ANNUITY :
L : NPVL / PVIFA(10%,4) = 6,191 / 3.1699 = 1,953
L : 1,953
S : NPVS / PVIFA(10%,4) = 7,543 / 3.1699 = 2,379
S : 2,379
So we should choose Project S since it has larger cash inflow per year
B. NOW ASSUME THAT THE COST TO REPLICATE PROJECT S IN 2 YEARS IS ESTIMATED TO BE $105000...
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