Question

Question 2 (evaluating investment projects) General Motors (or Toyota) is thinking of investing in new production equipment, which will cost $500 million in year zero, and will generate cost savings of $300 million in year 1, $200 million in year 2, and $150 million in year 3. After 3 years, the salvage value is zero. The cost of capital (discount rate) is 25% for General Motors and 10% for Toyota. (Due to GM's recent bankruptcy, investors are scared to lend it money, so GM has to pay much higher interest rates to attract capital) Required: a) What's the NPV of this project for General Motors? NPV $ million (If you get say $3.52 million, enter 3.52 not 3,520,000. If you get a negative number, enter it with a minus sign, i.e., -3.52 not (3.52)) Should GM invest, based on NPV? (1=yes, 2=no) b) What's the NPV of this project for Toyota? NPV = million $ Should Toyota invest, based on NPV? (1 yes, 2=no)

Answer 1

NPV = Present value of cash inflows – Present value of cash outflows

For General Motors

NPV = -500 million + 300 million/(1.25) + 200 million/(1.25)^2 + 150 million/(1.25)^3

= -$55.2 million

No, since NPV is negative i.e. 2

NPV for Toyota = -500 million + 300 million/(1.10) + 200 million/(1.10)^2 + 150 million/(1.10)^3

= $50.71 million

Yes