Reference no: EM132967350

Question - 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%

Required -

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

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

c. Calculate the Profitability Index?