Question

Kim Inc. must install a new air conditioning unit in its main plant. Kim must install one or the other of the units; otherwise, the highly profitable plant would have to shut down. Two units are available, HCC and LCC (for high and low capital costs, respectively). HCC has a high capital cast but relatively low operating costs, while LCC has a low capital cost but higher operating costs because it uses more electricity. The costs of the units are shown here. Kim's WACC is 5.5%. 0 1 2 3 4 5 HCC-$590,000 - $50,000 $50,000 - $50,000 - $50,000 - $50,000 LCC -$100,000-$175,000-$175,000-$175,000-$175,000-$175,000 a. Which unit wauld you recommend? I. Since we are examining costs, the unit chosen would be the one that had the lower NPV of costs. Since HCC's NPV of costs is lower than LCC's, HOC would be chosen. 11. Since we are examining costs, the unit chosen would be the one that had the lower NPV of costs. Since LCC's NPV of costs is lower than HCC's, LCC would be chosen. III. Since all of the cash flows are negative, the NPV's cannot be calculated and an alternative method must be employed. IV. Since all of the cash flows are negative, the NPV's will be negative and we do not accept any project that has a negative NPV. V. Since all of the cash flows are negative, the IRR's will be negative and we do not accept any project that has a negative IRR. |-Select- b. If Kim's controller wanted to know the IRRs of the two projects, what would you tell him? 1. The IRR of each project is negative and therefore not useful for decision-making. II. The IRR cannot be calculated because the cash flows are all one sign. A change of sign would be needed in order to calculate the IRR. III. The IRR cannot be calculated because the cash flows are in the form of an annuity, IV. The IRR of each project will be positive at a lower WACC. V. There are multiple IRR's for each project. -Select- c. If the WACC rose to 11% would this affect your recommendation? 1. When the WACC Increases to 11%, the IRR for HCC is greater than the IRR for LCC, HCC would be chosen. II. Since all of the cash flows are negative, the NPV's will be negative and we do not accept any project that has a negative NPV. III. When the WACC increases to 11%, the NPV of costs are now lower for LCC than HCC. IV. When the WACC increases to 11%, the NPV of costs are now lower for HCC than LOC. V. When the WACC increases to 11%, the IRR for LCC is greater than the IRR for HCC, LCC would be chosen. -Select- Explain your answer and the reason this result occurred. I. The reason is that when you discount at a higher rate you are making negative CFs higher thus improving the NPV. II. The reason is that when you discount at a higher rate you are making negative CFs higher and this lowers the NPV. III. The reason is that when you discount at a higher rate you are making negative CEs smaller and this lawers the NPV. IV. The reason is that when you discount at a higher rate you are making negative CFs smaller thus improving the NPV. V. The reason is that when you discount at a higher rate you are making negative CFs higher thus improving the IRR. -Select-

Answer 1

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

PV FACTOR = 1/(1+r)^n

C W ENG 02:54 31-07-2020 99+ 29 Х QE362 . PY PZ QA QB QC QD QE QF 360 361 362 363 364 1/(1+r)^n PV FACTOR AT 5.5% HCC LCC year HCC LCC 365 366 PV OF CFAT A*C PV OF CFAT B*C B C 0 A -590000 -50000 1 -590000 -100000 -100000 -175000 1 0.947867 0.898452 2 -50000 3 -50000 0.851614 367 368 369 370 371 372 373 374 375 376 -175000 -175000 -175000 -175000 -47393.36 -44922.62 -42580.68 -40360.84 -38256.72 -803514.22 -165876.78 -157229.17 -149032.39 -141262.93 -133898.51 -847299.78 4 -50000 -50000 0.807217 0.765134 5 NPV - a SINCE WE ARE EXAMINING COSTS, THE UNIT CHOSED WOULD BE ONE WITH LOWER NPVs AS HCC HAS LOWER NPV OF COSTS HCC SHOULD BE CHOSEN 377 378 b II 379 380 381 CORRECT ANSWER IRR CAN NOT BE CALCULATED BECAUSE ALL CASHFLOWS ARE NEGATIVE, SAME SIGN CHANGE OF SIGN NEEDED IN ORDER TO CALCULATE IRR 382 383 с IF WACC ROSE TO 11% EAC MACRS RELEVANT Ml-np-ir BETA LEVERED NPV CCA REPLACEMENT BOND OPTION TO WAIT STEIN indiffEPS EBIT OCF 1 LEA ... +

C W ENG 02:56 31-07-2020 99+ 29 Х QA403 . PY PZ QA QB QC QD QE QF 381 с IF WACC ROSE TO 11% 382 383 384 385 386 LCC PV FACTOR AT 11.0% year НСС LCC НСС PV OF CFAT A*C PV OF CFAT A B C B*C 387 0 -590000 -100000 1 1 -175000 388 389 390 -50000 -50000 -590000 -45045.05 -40581.12 2 -175000 -100000 -157657.66 -142033.93 -127958.49 -115277.92 -103853.98 3 -175000 0.900901 0.811622 0.731191 0.658731 0.593451 -50000 -50000 -36559.57 -32936.55 391 4 -175000 392 5 -50000 -175000 -29672.57 393 NPV -774794.85 -746781.98 394 395 CORRECT ANSWER WHEN WACC INCREASES TO 11%, THE NPV OF COSTS ARE NOW LOWER FOR LCC THAN HCC 396 397 398 399 400 401 402 EXPLAIN YOUR ANSWER AND THE REASON THIS RESULT OCCURRED IV CORRECT ANSWER THE REASON IS THAT WHEN YOU DISCOUNT AT A HIGHER RATE YOU ARE MAKING NEGATIVE CFS SMALLER, AND THIS IMPROVING NPV 403 404 Horizontal (Value) Axis Minor Gridlines MI-np-ir BETA LEVERED NPV | CCA EAC MACRS RELEVANT REPLACEMENT BOND OPTION TO WAIT STEIN indiffEPS EBIT OCF 1 LEA ... +