Reference no: EM132885454

Mississippi River Apartments may upgrade its modem pool. They last upgraded the pool two years ago when they spent $110 million on pool equipment with a useful life of 5 years and a salvage value of $10 million for accounting purposes. The firm uses straight-line depreciation.

A new modem pool equipment can be installed today for $160 million. It will be depreciated over a three-year useful life and the salvage value is $10 million. Working capital requirements are as follows:

Year 0:$10,000,000

Year 1:$7,200,000

Year 2:$6,000,000

Year  3: $0

• The economic life of the project is three years.
• Mississippi River Apartments can sell the old pool equipment today and get $80 million before taxes (i. e, Year O).
• Mississippi River Apartments will not expect to recover the NWC invested.
• The new pool equipment will enable the firm to have revenues of $200 million each year for the next three years. The old pool is currently generating revenues of $120 million per year.
• Variable costs are 40% of sales with the new pool or the current pool.
• At the end of the project, you can sell the new pool equipment for $5 million.
• Assume the firm has a 35% average tax rate and 30% marginal rate.
• Mississippi River Apartments has a Beta of 1.2, the market return is 11% and the risk-free rate is 3%

Problem a. Calculate the NPV Should you replace the current modem pool

Problem b. Based on the IRR rule, should you replace the current modem pool

Problem c. Calculate the Profitability Index