AOL is considering two proposals to overhaul its network infrastructure. They have received two bids. The first bid from Huawei will require a $18 million upfront investment and will generate $20 million in savings for AOL each year for the next 3 years. The second bid from Cisco requires a $96 million upfront investment and will generate $60 million in savings each year for the next 3 years.
a. What is the IRR for AOL associated with each bid?
b. If the cost of capital for each investment is 13%, what is the net present value (NPV) of each bid?
Suppose Cisco modifies its bid by offering a lease contract instead. Under the terms of the lease, AOL will pay $28 million upfront, and $35 million per year for the next 3 years. AOL's savings will be the same as with Cisco's original bid.
c. What is the IRR of the Cisco bid now?
d. What is the new NPV?
e. What should AOL do?