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CB Integrative Case SPR14
CB Integrative Case SPR14
CB Integrative Case SPR14
Review Implementation
Proposal Decision
& and
Generation Making
Analysis Follow-up
Cash $25,400
A/R $120,000
Inventories ($20,000)
A/P $35,000
EBITDA
Year Old Press Press A Press B
1 $120,000 $250,000 $210,000
• Using the data developed in part a, find and depict on a time line the relevant cash flow
stream associated with each of the two proposed replacement presses, assuming that each is
terminated at the end of 5 years.
• Using the data developed in part b, apply each of the following decision techniques:
– ( 1) Payback period (2) Discounted Payback Period (3) NPV (4) IRR (5) MIRR (6) Profitability Index
• Draw net present value profiles for the two replacement presses on the same set of axes,
and discuss conflicting rankings of the two presses, if any, resulting from use of NPV and
IRR decision techniques.
• Recommend which, if either, of the presses the firm should acquire if the firm has
( 1) unlimited funds ( 2) capital rationing.
• What is the impact on your recommendation of the fact that the operating cash inflows
associated with press A are characterized as very risky in contrast to the low- risk operating
cash inflows of press B?
Existing Machine 1 2 3 4 5
EBITDA 120000 120000 120000 120000 120000
Depreciation $48,000 $48,000 $20,000 $0 $0
EBT $72,000 $72,000$100,000 $120,000 $120,000
Taxes $28,800 $28,800 $40,000 $48,000 $48,000
Net Income $43,200 $43,200 $60,000 $72,000 $72,000
Depreciation $48,000 $48,000 $20,000 $0 $0
NOCF $91,200 $91,200 $80,000 $72,000 $72,000
Net Operating Cash Flows: Press-A
PRESS-A: 1 2 3 4 5
PRESS-B: 1 2 3 4 5
Column1 1 2 3 4 5
Existing Machine $91,200 $91,200 $80,000 $72,000 $72,000
Press-A $219,600 $273,360 $246,120 $239,760 $263,760
Press-B $178,800 $210,480 $176,160 $157,680 $157,680
Press A IOCF $128,400 $182,160 $166,120 $167,760 $191,760
Press B IOCF $87,600 $119,280 $96,160 $85,680 $85,680
Terminal Cash Flows
347,800-90,000=257,800 211,200-90,000=121,200
Relevant Cash Flow for the Projects
Note that the cost for Press A (662,000) can be recovered only sometime
between 4th and 5th year. The portion recovered in the 5th year is
(662,000-644,440)/449,560=0.0391. Therefore payback period for the
Press A is 4 years + 0.09 Years or 4.04 years. The recovery for press B is faster
as initial investment of 361,600 can be recovered in 3.68 years.
Discounted Payback Period
Cumulative Cumulative
Press A Press B
Cash Flows A Cash Flows B
Year
0 (662,000) (361,600) (662,000) (361,600)
1 112,632 76,842 112,632 76,842
2 140,166 91,782 252,798 168,624
3 112,126 64,905 364,924 233,529
4 99,327 50,729 464,251 284,259
5 233,487 107,447 697,739 391,706
Discounted Payback
Period 4.85 4.72
2 $182,160 $119,280
87, 600 119, 280 96,160
NPVB
(1 0.14) (1 0.14)
1 2
(1 0.14)3
3 $166,120 $96,160
85,860 206,880
361, 600 30,105.88
(1 0.14) 4
(1 0.14)5
4 $167,760 $85,680
5 $449,560 $206,880
NPVPress-A=35,738.82>NPVPress-B=30,105.88
Since both projects have 5 year life spans there is no need to consider
Annualized NPV, but have we had done it, ANPV-A would have been
higher than ANPV-B.
IRR
• Both projects have IRR above cost of Capital. If we used IRR to choose the
projects, Press B would be favored by the IRR method. Note that IRR assumes
that cash flows can be reinvested at the IRR.
• A consideration of reinvestment at cost of capital (MIRR) suggest that ranking
does not change. MIRR-A=15% MIRR-B=16%
$300,000
Cross-over point=14.59%
$200,000 Project A
$100,000
Project B
$0
-$100,000
-$200,000
-$300,000
NPV_A NPV_B
Profitability Index
I
• LI’s two projects have PIA=1.05 and PIB=1.08 . While
profitability index suggests that project B generates more
value per dollar invested, the total value created by project A
is higher.
Consider the two projects above with different initial outlays and cash
flow structures. The company in question should choose one of these
two service station projects. Which one should company adopt?
Since these are mutually exclusive projects, it does not make sense to
adopt both.
• Under capital rationing, the company has a fixed investment budget that
it may not exceed.
• Capital rationing requires us to rank investments rather than simply
accept or reject them.
• In mutually exclusive alternatives, capital is available but, for technical
reasons, the company cannot make all investments.
• Under capital rationing, it may be technically possible to make all
investments, but there is limited capital. This has a fundamental impact
on the ranking processes.
• When capital is constrained, the objective is to get best possible benefit
per dollar.
Answer:
Undertake investment A because it has the highest NPV, and NPV is a direct
measure of the increase in wealth from undertaking the investment