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generate cash flow of $5000 per year. The machine costs 35000 and expected to
last for 15 years. Rainbow products determine the cost of capital is 12%.
[A] On the slide I have stream of cash flow from the date of purchase t=0 till 15
years later. This is an annuity, in which the paint mixing machine pays out a fixed
cash flow of 5000 annually for 15 years.
With the investment cost of 35000 and discount rate of 12%, using excel function,
we get NPV= -945.68, IRR =11.49%, pay back period is 7 years.
Should not purchase the project
[B] with $500 additional expenditure, Rainbow products can get a service that can
keep the machine in new condition forever. With the service contract, the machine
would produce cash flows of $4500 per year perpetuity.
Should purchase the project with service contract.
[C]Instead of service contract, Rainbow engineers come up with a plan that can
preserve and enhance the machine capability by reinvesting 20% of the annual cost
saving back into new machine parts to increase cost savings at 4% per year
perpetuity.
The slide show cost saving increasing 4% per year, and 20% cost saving will be
reinvested. Subtracting the cost of reinvestment, we will get a stream of perpetual
cash flow also grow at 4%.
This is an example of growing perpetuity,
Three projects are mutually exclusive, rainbow should go with the third one cause
highest NPV and IRR.
2) Concession stand with three years left on the contract with the park. Long lines
limits sales and profits.
We have four different proposals and with incremental cash flows.
775
35%
271.25
40%
310
323
35%
113.05
40%
129.2
Lockheed had overestimated the demand because its break even point was 480 unit at
production cost of $12.5 million per unit.
Number of share
outstanding
Jan-67
Jan-71
11,300,000
63
10
$598,900,00
0.00)
Lockheed should go seek for a $250 million federal guarantee to secure bank credit required for
completion the Tri Star program.