The large publishing company you work for has built up an excess pile of $200M cash due to better than expected sales and delays in making any new investments in production facilities. As the newly promoted Chief Financial Officer, the CEO has instructed you to find uses of this unneeded cash that will earn the highest return for shareholders; liquidity (ease of convertibility into cash) is not an issue. You may also invest any amount of cash (from $200M to any remaining after investments) into a stock market index expected to earn 7% per year or distribute to shareholders as a dividend. Please note that your cost of capital to consider for the project(s) you choose is 11%.
You can team with Amazon in creating your own e-Reader in order to join the movement towards e-books and away from printed copies. Your company has already spent $20M researching the technological requirements and possible market reaction. Amazon requires an upfront investment of $90M to begin design and expects the product to hit the market next year. This will reduce cash flows from traditional book sales by $15M per year in addition to the increased sales and costs shown below. Projected cash flows for this investment are as follows:
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Sales $65M $70M $70M $75M $80M $85M
Costs ($50M) ($45M) ($40M) ($40M) ($40M) ($40M)
1. Compute the Payback Period, Net Present Value and Internal Rate of Return.