Question

Choo Choo Inc. is a manufacturer of model trains. The company is considering the purchase of an industrial 3D printer, which will allow the firm to produce custom-made model trains for its high-end customers. The printer will cost $2,500,000, and it is expected to produce net cash flows of $600,000 per year for the next six years.  Liquidation of the equipment will net the firm $350,000 in cash at the end of six years. The firm requires a 15% rate of return on all investments. Ignore the effects of taxes.                                                                         (12 marks total)

a.  What is the payback period for the proposed investment in the 3D printer? Provide your answer in number of years and months.                             (1 mark)

b.  What is the printer’s discounted payback period? Provide your answer in number of years and months.                                                       (2 marks)

c.  Choo Choo’s cutoff period is set at five years. Based on the payback period investment criterion, will the company purchase the printer? Will it purchase the printer based on the discounted payback period investment criterion?       (1 mark)

d.  What is the printer’s net present value (NPV)? Should the company purchase the printer based on the NPV investment criterion?                                                                                       (2.5 marks)

e.  What is the printer’s profitability index (PI)? Should the company purchase the printer based on the PI investment criterion?                        (1.5 marks)

f.   What is the printer’s internal rate of return (IRR)?                           (2 marks)

g.  Check that at the internal rate of return (IRR) the net present value of the printer is $0. Should the company purchase the printer based on the IRR investment criterion?                             (1.5 marks)

h.  Based on your answers in parts a to f above, what decision do you recommend for Choo Choo?                                                                 (0.5 mark)

Answer 1

a & c
Printer
Year	Cash flow stream	Cumulative cash flow
0	-2500000	-2500000
1	600000	-1900000
2	600000	-1300000
3	600000	-700000
4	600000	-100000
5	600000	500000
6	950000	1450000
Payback period is the time by which undiscounted cashflow cover the intial investment outlay
this is happening between year 4 and 5
therefore by interpolation payback period = 4 + (0-(-100000))/(500000-(-100000))
4.17 Years
Accept project as payback period is less than 5 years
b & c
Printer			Discount rate=	0.15
Year	Cash flow stream	Cumulative cash flow	Discounting factor	Discounted CF	Cumulative cash flow	Cumulative discounted CF
0	-2500000	-2500000	1	-2500000	-2500000	-2500000
1	600000	-1900000	1.15	521739.1	-1900000	-1978261
2	600000	-1300000	1.3225	453686.2	-1300000	-1524575
3	600000	-700000	1.520875	394509.7	-700000	-1130065
4	600000	-100000	1.749006	343051.9	-100000	-787013
5	600000	500000	2.011357	298306	500000	-488707
6	950000	1450000	2.313061	410711.2	1450000	-77995.7
Discounted payback period is the time by which discounted cashflow cover the intial investment outlay
This is not happening during project life hence it cannot be calculated
Where
Discounting factor =(1 + discount rate)^(corresponding year)
Discounted Cashflow=Cash flow stream/discounting factor
d
Printer
Discount rate	0.15
Year	0	1	2	3	4	5	6
Cash flow stream	-2500000	600000	600000	600000	600000	600000	950000
Discounting factor	1	1.15	1.3225	1.520875	1.7490063	2.011357	2.313061
Discounted cash flows project	-2500000	521739.1	453686.2	394509.7	343051.95	298306	410711.2
NPV = Sum of discounted cash flows
NPV Printer =	-77995.73
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Reject project as NPV is negative

Please ask remaining parts seperately