To: ABC Inc.
Date: September 30, 2013
Re: Problem 1&2&3
In the first problem, based on a careful study, the project will have the following performance:
a) The exact Payback Period is 4.62 years
b) The discounted Payback Period is 5.58 years
c) The Internal Rate of Return (IRR) of the machine is 13.87%
d) The Net Present Value (NPV) is $1,136,020.85
e) The Profitability Index (PI) associated with the project is 1.14
If we make decision based on NPV or IRR or PI, we should accept this project. This is because the project has a positive NPV, its PI over 1 and the IRR is more than the required rate of return. All of this factors mean that the project can actually benefit the company. However, since your company required that all the projects have a payback period of 2 years or less and a discounted payback period of 2.5 years or less, I recommend that you should reject this particular project. This is because the exact Payback Period and discounted Payback Period are 4.62 years and 5.58 years, which are far beyond the requirements. Therefore, the project should be reject.
I also make some sensitivity analysis and scenario analysis as you required. In the sensitivity analysis, you can see that the change of the price per unit has the greatest impact on the NPV. If the price per unit decreases by 10%, the NPV will be -694,837.57 and the IRR will be 7.59%, which means the project will make the company lose money on this investment. Based on your requirements, I also do a scenario analysis. You can see it in the appendix. Since you just require the NPV and IRR results, the others are not show there, you should notice that if you pretty sure that the good case may happen, you can accept the project. This is because in the best case, all your company’s requirements will be achieved and the NPV and IRR of the project will increase a lot (The NPV will be 14,907,810.60 and the IRR will be 54.06%). However, if