a. Nipper Corp., which sells glow-in-the-dark pacifiers to anxious parents, wants to expand its capacity. Nipper is considering buying a new piece of equipment that would cut the radioactivity in each pacifier. One alternative would cost them $75,000 for new machinery and provide them with cash flows of $28,000 per year for the next four years. The other would cost $187,000 but would result in cash flows of $65,000 a year over the same 4 year period. Assuming that the cost of capital Nipper faces is 12.5%, evaluate the NPV and IRR of these projects and determine which one of these two mutually exclusive alternatives you would choose. Explain your reasoning. Show all work!
b.Assume you are the financial manager with a hard capital rationing constraint of $18 million. You may invest in the following independent projects. Investment and cash flow figures are in millions.
PROJECT, INVESTMENT, NPV
A, 6, 2
B, 4, 1
C, 9, 3
D, 5, 1
E, 2, 1
Using the Profitability Index, which projects should you choose given the budget constraint and which would you choose if there was no capital rationing? Show all work