“Profitability Index versus NPV Hanmi Group, a consumer electronics conglomerate, is reviewing its annual budget in wireless technology. It is considering investments in three different technologies to develop wireless communication devices. Consider the following cash flows of the three independent projects for Hanmi. Assume the discount rate for Hanmi is 10 percent. Further, Hanmi Group has only $20 million to invest in new projects this year”
Cash Flows (in $ millions)
Year CDMA G4 Wi-Fi
0 -8 -12 -20
1 11 10 18
2 7.5 25 32
3 2.5 20 20
a. Based on the profitability index decision rule, rank these investments.
b. Based on the NPV, rank these investments.
c. Based on your findings in (a) and (b), what would you recommend to the CEO of Hanmi Group and why?
16. Comparing Investment Criteria Consider the following cash flows of two mutually exclusive projects for AZ-Motorcars. Assume the discount rate for AZ-Motorcars is 10 percent. ”
Year AZM Mini-SUV AZF Full-SUVG4
0 -450000 -800000
1 320000 350000
2 180000 420000
3 150000 290000
a. Based on the payback period, which project should be accepted?
b. Based on the NPV, which project should be accepted?
c. Based on the IRR, which project should be accepted?
d. Based on this analysis, is incremental IRR analysis necessary? If yes, please conduct the analysis.
“Project Analysis and Inflation Sanders Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $270,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value after the seven years. Operating revenues from the facility are expected to be $105,000, in nominal terms, at the end of the first year. The revenues are expected to increase at the inflation rate of 5 percent. Production costs at the end of the first year will be $30,000, in nominal terms, and they are expected to increase at 6 percent per year. The real discount rate is 8 percent. The corporate tax rate is 34 percent. Sanders has other ongoing profitable operations. Should the company accept the project?”
“Nominal Discount Rate = (1+Real Discount Rate)*(1+Inflation) -1
Nominal Discount Rate= (1+.08)*(1+.05) – 1 = .1340 or 13.40%
Nominal Discount Rate would be used to calculate NPV.”
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