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Scale Differences The Pinkerton Publishing Company is considering two mutually exclusive expansion plans. Plan A calls for th
Project B: b. Set up a Project A by showing the cash flows that will exist if the firm goes with the large plant rather than
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Answer #1

Answering a)

Project A
Year 0 (Initital investment) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Cash flows -47 7 7 7 7 7 7 7 7 7 7 7 7 7 7 7 7 7 7 7 7
PV of Cash Flows -47 6.25 5.58 4.98 4.45 3.97 3.55 3.17 2.83 2.52 2.25 2.01 1.80 1.60 1.43 1.28 1.14 1.02 0.91 0.81 0.73
Cost of capital 12%
NPV 5.29
IRR 13.76%

We Arrive at PV of Cash Flows by discounting them by the cost of capital = 12% for the number of years required to shift it to t = 0. For e.g. cash flow of 7 million of year 3 is calculated as 7 / (1.12)^3 to arrive its value of 4.98 at t = 0.

We calculate the NPV by summing all the PV of Cash Flows, Hence NPV = PV of Cash Flow

E.g. NPV for Project A = (6.25 + 5.58 + 4.98 + ....... + 0.73) = 5.29

We calculate IRR using ne = San IRR = Z (1+r)t-Co t-1 Click to enlarge Where: Ct = Net Cash Inflow During the Period t r = Discount Rate t = Number

Project B
Year 0 (Initial Investment) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Cash flows -13 3.1 3.1 3.1 3.1 3.1 3.1 3.1 3.1 3.1 3.1 3.1 3.1 3.1 3.1 3.1 3.1 3.1 3.1 3.1 3.1
PV of Cash Flows -13 2.77 2.47 2.21 1.97 1.76 1.57 1.40 1.25 1.12 1.00 0.89 0.80 0.71 0.63 0.57 0.51 0.45 0.40 0.36 0.32
Cost of capital 12%
NPV 10.16
IRR 23.50%

b) The Cash Flows for project A are shown in the above table & also given below:

For year 0 = (-47 million) (negative as it is Cash Outflow)

For year 1 - 20 = +7 million each year = 140 million ( positive as it is Cash Inflow)

While the NPV and the IRR values remain the same as Project A. i.e

NPV = 5.29 and IRR = 13.76 %

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