Question: Crumbly Cookie Company is considering expanding by buying a new (additional) machine that costs $42,000, has zero terminal disposal value and a 10-year useful life. It expects the annual increase in cash revenues from the expansion to be $23,000 per year. It expects additional annual cash costs to be $16,000 per year. Its cost of capital is 6%. Ignore taxes.
Q1. Calculate the net present value and internal rate of return for this investment.
Q2. Assume the finance manager of Crumbly Cookie Company is not sure about the cash revenues and costs. The revenues could be anywhere from 10% higher to 10% lower than predicted. Assume cash costs are still $16,000 per year. What are NPV and IRR at the high and low points for revenue?
Q3. The finance manager thinks that costs will vary with revenues, and if the revenues are 10% higher, the costs will be 7% higher. If the revenues are 10% lower, the costs will be 10% lower. Recalculate the NPV and IRR at the high and low revenue points with this new cost information.
Q4. The finance manager has decided that the company should earn 2% more than the cost of capital on any project. Recalculate the original NPV in #1 using the new discount rate and evaluate the investment opportunity.
Q5. Discuss how the changes in assumptions have affected the decision to expand.