Question

You go to your desk and your boss comes in. "I need you to do some work for me. Read this and tell me what you think." The assignment indicates that following" StuartCo Trains is a large Tank maker. It recently built the T123. It can carry a huge payload and is more nimble than other tanks. Initial project investments were $13B. Assume that the initial investment was paid on Dec 31, 2010. Assume that StuartCo will produce 60 Tanks per year for five years. Each Tank will be sold for $230M and total operating costs are 75% of revenues. Assume that revenues and costs occur at year-end with the first revenues (and costs) occurring on Dec 31, 2011. The assignment your boss gives you asks you to determine the NPV of the project if StuartCo's cost of capital is 11%? Calculate the NPV as of Dec 31, 2010. Ignore taxes and assume that there are no terminal year cash flows. Show your work, as appropriate and clearly state your answer (5 points)Your boss then asks what is the payback period for the StuartCo investment outlined above? Amd, the CEO doesn't really get payback - so how should I explain it to him. What does the payback period calculation mean? (5 marks)

Your boss than asks you to calculate the Profitability Index as of Dec 31, 2010 for the StuartCo investment outlined in #4 above. (4 marks)
Your boss wants a recommendation - but based on only one of the three sets of analysis above (either NPV, Payback or Profitability Index). Which method do you choose? Why?
Your boss now asks you to tackle something new. StuartCo is now planning to make a special add-on investment to its tanks. The changes will cost $3 million in total, with the expenditure occurring at the end of the year three years from today. The changes will bring year-end after-tax cash inflows of $2 million at the end of the two succeeding years. It will then cost $.5 million to dispose of specialized waste generated by the project at the end of the 3rd year of operation. Your boss asks you the following:
What is the project's IRR?
If StuartCo Industries requires a minimum return of 10%, should this project be accepted? Why? What if the minimum return was 15%?
StuartCo is now considering two independent projects utilizing the internal rate of return technique. Project A has an initial investment of $120,000 and cash inflows at the end of each of the next four years of $40,000. Project B has an initial investment of $80,000 and cash inflows at the end of each of the next five years of $25,000.
Which projects should be accepted if the cost of capital is 15%?
Which projects should be accepted if the cost of capital is 10%

Answer 1

The student's question revolves around calculating NPV, payback period, Profitability Index, and IRR to evaluate a business investment. Recommendations are given preference to NPV because it provides a comprehensive view of the project's value over time. The IRR method is used to decide whether to proceed with an add-on investment to existing products.

Step-by-step explanation:

The question involves calculating various financial metrics to assess the viability of a business investment project, including Net Present Value (NPV), payback period, Profitability Index, and Internal Rate of Return (IRR). The NPV calculation involves discounting future cash flows back to their present value using the company's cost of capital, which in this case is 11%. The payback period is the time it takes for an investment to generate cash flows to recover the initial investment costs. The Profitability Index is a ratio that compares the present value of future cash flows to the initial investment. Lastly, the IRR is the discount rate at which the NPV of an investment is zero, and it's used to evaluate the attractiveness of a project.

To provide recommendations to the boss, we would likely suggest using the NPV method as it measures the absolute value created by the investment and takes into account the time value of money, which is a crucial component in investment decisions. As for the add-on investment to the tanks and the IRR calculation, we would analyze the cash flows and discount rates to determine whether the project's IRR exceeds the company's required return, thereby deciding if it should be accepted.