Problem:
Eagle Feather Company is considering investing in a new process which would improve manufacturing efficiency in the production of its principal product. The company can either invest in Process A for $150,000 which is easy to install and immediately begins to return cash back to the company, or Process B for $250,000 which is much more difficult to install but has the potential of returning greater cash flows in improved efficiencies. The after tax cash flows of the new processes are as follows:
Process A Process B
Initial Investment -$150,000 -$250,000
Year 1 $ 45,000 $ 25,000
Year 2 $ 55,000 $ 45,000
Year 3 $ 65,000 $125,000
Year 4 $ 75,000 $150,000
Year 5 $ 85,000 $175,000
Q1. If the company's Cost of Capital is 13%, what is the Payback, Net Present Value, and Profitability Index for each of these projects?
Q2. The Controller has calculated that the Internal Rate of Return on Project A is 29% and on Project B is 22%. She wants to undertake Project A. What do you recommend based on your analysis?