Reference no: EM1313900

Explain Capital Budgeting decision based on IRR of the project

1)Darling Inc. is evaluating the purchase of a new centrifuge, used to settle out fine particles from the liquid feed ingredients that the firm produces. The old centrifuge was purchased from the Stern Corporation, but must be replaced due to a new EPA mandate limiting energy consumption for centrifuges. A new energy efficient Stern centrifuge would cost $350,000 and have a useful life of 6 years. However, the firm is also evaluating the purchase of a Byrd centrifuge, which would cost $450,000 and have a useful life of 10 years. Although the Stern centrifuge is less expensive, the yearly cost of maintenance (at the end of each year) would be $30,000. The Byrd centrifuge can be operated for a full two-year period without maintenance, requiring an extensive overhaul costing $50,000 at the end of each two-year operating cycle. The Internal Revenue Service permits manufacturing equipment to be depreciated to a zero salvage value over a 5-year life. Assuming that Darling has a tax rate of 30 percent and that Darling's opportunity cost of capital (required return) is 10 percent, determine whether the firm should purchase the centrifuge from Byrd or Stern.

2)Webb Industries, a diversified manufacturer of fiberglass products, is considering a proposal by the CEO to sell the firm's boat manufacturing division. An anonymous buyer has offered (through a business broker) to purchase the boat division from Webb for $25 million. Since the book value of the boat division is also $25 million, there would be no taxes on the sale. Boat sales in the upcoming fiscal year are expected to be $20 million. However, yearly sales have been declining steadily at a rate of 4 percent per year. The CFO believes that the trend in boat sales cannot be reversed, and that sales in the boat division will continue to decline (in perpetuity) at a rate of 4 percent per year due to relentless competition from manufacturers located in Paraguay. As further evidence supporting the proposed sale, the CFO notes that Webb's profit margin on boat sales is only 15 percent (of sales). The CFO has argued that selling the boat division is not attractive because the proposed sale offers Webb has an internal rate of return that is greater than the firm's opportunity cost of capital of 10 percent. Assuming that Webb has a marginal tax rate of 30 percent,

a. Determine the internal rate of return for the proposed sale,

b. Explain whether Board should approve the sale of the boat division.