Contact Manufacturing Inc. is considering two alternative investment proposals.

The first proposal cal

manufacturing facility. The second involves replacing just a few obsolete pieces of equipment in the f
one project or the other this year, but not both. The cash flows associated with each project appear b
project cash flows at 15 percent.

Year Renovate Replace

0 ($9,000,000) ($2,400,000)
1 3,000,000 2,000,000
2 3,000,000 800,000
3 3,000,000 200,000
4 3,000,000 200,000
5 3,000,000 200,000

1. Calculate the payback period of each project and based on the criteria for which project would you

Year Renovate Replace

0 ($9,000,000) ($2,400,000)
1 3,000,000 2,000,000
2 3,000,000 800,000
3 3,000,000 200,000
4 3,000,000 200,000
5 3,000,000 200,000
payback period 3 1.5
based on payback criteria replacement would be recommended as it has shorter payback ti

2. Calculate the net present value (NPV) of each project and based on this criteria for which project w
acceptance?
Year Renovate Replace

0 ($9,000,000) ($2,400,000)
1 3,000,000 2,000,000
2 3,000,000 800,000
3 3,000,000 200,000
4 3,000,000 200,000
5 3,000,000 200,000
NPV 1,056,465 289,335
based on NPV criteria renovation would be recommended as it has higher NPV.
3. Calculate the internal rate of return (IRR) of each project and based on this criteria for each projec
acceptance?

Year Renovate Replace

0 ($9,000,000) ($2,400,000)
1 3,000,000 2,000,000
2 3,000,000 800,000
3 3,000,000 200,000
4 3,000,000 200,000
5 3,000,000 200,000
IRR 20% 24%
based on IRR criteria replacement would be recommended as it has higher IRR.

4. Calculate the profitability index (PI) of each project and based on this criteria for which project wo

Year Renovate Replace

0 ($9,000,000) ($2,400,000)
1 3,000,000 2,000,000
2 3,000,000 800,000
3 3,000,000 200,000
4 3,000,000 200,000
5 3,000,000 200,000
Profitability index 1.1174 1.1206
based on PI criteria replacement would be recommended as it has higher index.

5. Overall, you should find conflicting recommendations based on the various criteria. Why is this occ

The rankings provide mixed signals because of the differing cash flow patterns and initial i
projects. Projects that have lower initial investments and return their cash flows earlier in
have higher IRRs, as is the case with the Replace project.

6. Chart the NPV profiles of these projects. Label the intersection points on the X and Y axis and the c

COST OF CAPITAL
NPV OF RENOVATION NPV OF REPLACEMENT

0% 6,000,000 1,000,000
10% 2,372,360 490,389
15% 1,056,465 289,335
20% -28,164 114,789
25% -932,160 -38,144
30% -1,693,291 -173,241
 35% -2,340,116 -293,456
40% -2,894,508 -401,130
45% -3,373,418 -498,141
50% -3,790,123 -586,008

8,000,000
6,000,000
4,000,000
2,000,000
0
-2,000,0000% 10% 15% 20% 25% 30% 35% 40% 45% 50%

-4,000,000
-6,000,000
RENOVATE REPLACEMENT

7. Based on this NPV profile analysis and assuming the WACC is 15%, which project is recommended

Assuming WACC is 15% renovation should be recommended as at this point the renovation
than replacment curve

8. Based on the NPV profile analysis and assuming the WACC is 25%, which project is recommended

Assuming WACC is 25% replacement should be recommended as at this point the replacem
than renovation curve

9. Discuss the important elements to consider when deciding between these two projects.

Replacment has the higher PI and IRR, but Renovation is a larger scale project with a high
exclusive projects are the only ones available and if there is sufficient capital to finance ren
accepted because it contributes the most to shareholder value.
roposals. The first proposal calls for a major renovation of the
e pieces of equipment in the facility. The company will choose
ted with each project appear below and the firm discount

ia for which project would you recommend accepting?

as it has shorter payback time.

this criteria for which project would you recommend

has higher NPV.

 on this criteria for each project, which would you recommend

has higher IRR.

s criteria for which project would you recommend acceptance?

as higher index.

arious criteria. Why is this occurring?

h flow patterns and initial investments of the two

n their cash flows earlier in the life of the project tend to

s on the X and Y axis and the crossover point.

%

which project is recommended and why?

at this point the renovation curve is above

which project is recommended and why?

s at this point the replacement curve is above

these two projects.

er scale project with a higher NPV. If these mutually

ficient capital to finance renovation, then it should be