Reference no: EM133074681

1) Your firm spends $400,000 per year in regular maintenance of its equipment. Due to an economic slowdown, your boss is considering forgoing these maintenance expenses for the next 3 years. If done, you expect you will need to spend $1.5 million in year 4 to replace failed equipment.

a) What is the IRR of the decision to forgo maintenance of the equipment?

b) Does the [traditional] IRR rule work for this decision? For what costs of capital is forgoing maintenance a good decision?

2) You are deciding between two mutually exclusive investment opportunities. Both require the same initial investment of $20 million.

Investment A will generate $3 million per year (starting at the end of the first year) in perpetuity. Investment B will generate $2 million at the end of the first year and its revenues will grow at 3 percent per year for every year after that.

a) Which investment has the higher IRR?

b) Which investment has the higher NPV when the cost of capital is 6 percent?

c) Which investment has the higher NPV when the cost of capital is 12 percent?

d) Explain why there is a difference in your answers for part (b) and part (c). For what values of the cost of capital does picking the higher IRR give the correct answer as to which investment is the best opportunity?

3) Agglomerated Products Incorporated (API) is considering two mutually exclusive projects. Project A will require an investment of $20 million today, and will return $75 million at the end of 10 years (a one-time cash flow). Project B will cost $15 million today, but will return 3 million in EACH of the next 10 years.

Assuming API's weighted average cost of capital is 12 percent, use the incremental IRR rule to make the correct decision.