Crumbly Cookie Company is considering expanding by purchasing a new machine that costs $62,000, has zero terminal disposal value, and has a 10-year useful life. It expects the annual increase in cash revenues from the expansion to be $28,000 per year. It expects additional annual cash costs to operate the machine to be $18,000 per year. Its cost of capital is 8%. Ignore taxes.

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Crumbly Cookie Company is considering expanding by purchasing a new machine that costs $62,000, has zero terminal disposal value, and has a 10-year useful life. It expects the annual increase in cash revenues from the expansion to be $28,000 per year. It expects additional annual cash costs to operate the machine to be $18,000 per year. Its cost of capital is 8%. Ignore taxes.

1) What is the net present value & internal rate of return of this investment? Make your recommendation about whether to invest in this machine or not. Please lay out all your calculations and steps neatly in this worksheet. For the IRR calculations, all the steps in the trial-and-error must be presented.

Assume that the finance manager of Crumbly Cookie is not sure about the cash revenues and operating costs. Revenues could be anywhere from 10% higher to 10% lower than predicted. Assume cash costs are still $18,000 per year.
2) What are the project’s NPV and IRR at the high and low points for revenue?
What is your recommendation now?
Please lay out all your calculations and steps neatly in this worksheet. For the IRR calculations, all the steps in the trial-and-error must be presented.The finance manager, on further analysis, realizes that costs will vary with revenues. If revenues are 10% higher, costs will be 7% higher. If revenues are 10% lower, costs will be 10% lower.3) Recalculate NPV and IRR at the high and low revenue points with this new information.What is your recommendation now?Please lay out all your calculations and steps neatly in this worksheet. For the IRR calculations, all the steps in the trial-and-error must be presented.4) Please summarize all your recommendations here, and your overall impressions, if any.

EXPERT ANSWER

1)
YearInvestmentRevenuecostNet cash flowPv @8%Present Value
0-$62,000$0-$62,0001-$62,000
1$28,000-$18,000$10,0000.9259$9,259.26
2$28,000-$18,000$10,0000.8573$8,573.39
3$28,000-$18,000$10,0000.7938$7,938.32
4$28,000-$18,000$10,0000.7350$7,350.3
5$28,000-$18,000$10,0000.6806$6,805.83
6$28,000-$18,000$10,0000.6302$6,301.7
7$28,000-$18,000$10,0000.5835$5,834.9
8$28,000-$18,000$10,0000.5403$5,402.69
9$28,000-$18,000$10,0000.5002$5,002.49
10$28,000-$18,000$10,0000.4632$4,631.93
NPV$5,100.81
IRR9.79%
The company can make the investment because NPV is positive and IRR is more than cost of capital.
2)
Revenue 10% Higher
YearInvestmentRevenuecostNet cash flowPv @8%Present Value
0-$62,000$0-$62,0001-$62,000
1$30,800-$18,000$12,8000.9259$11,851.85
2$30,800-$18,000$12,8000.8573$10,973.94
3$30,800-$18,000$12,8000.7938$10,161.05
4$30,800-$18,000$12,8000.7350$9,408.38
5$30,800-$18,000$12,8000.6806$8,711.46
6$30,800-$18,000$12,8000.6302$8,066.17
7$30,800-$18,000$12,8000.5835$7,468.68
8$30,800-$18,000$12,8000.5403$6,915.44
9$30,800-$18,000$12,8000.5002$6,403.19
10$30,800-$18,000$12,8000.4632$5,928.88
NPV$23,889.04
IRR15.94%
Revenue 10% lower
YearInvestmentRevenuecostNet cash flowPv @8%Present Value
0-$62,000$0-$62,0001-$62,000
1$25,200-$18,000$7,2000.9259$6,666.67
2$25,200-$18,000$7,2000.8573$6,172.84
3$25,200-$18,000$7,2000.7938$5,715.59
4$25,200-$18,000$7,2000.7350$5,292.21
5$25,200-$18,000$7,2000.6806$4,900.2
6$25,200-$18,000$7,2000.6302$4,537.22
7$25,200-$18,000$7,2000.5835$4,201.13
8$25,200-$18,000$7,2000.5403$3,889.94
9$25,200-$18,000$7,2000.5002$3,601.79
10$25,200-$18,000$7,2000.4632$3,334.99
NPV-$13,687.41
IRR2.82%
The company can make investment when revenue increased by10% because NPV is positive and IRR is more than cost of capital.In case of revenue lowers by 10% its not feasible for company to invest as NPV is negative.
3)
Revenue 10% Higher and cost 7% higher
YearInvestmentRevenuecostNet cash flowPv @8%Present Value
0-$62,000$0-$62,0001-$62,000
1$30,800-$19,260$11,5400.9259$10,685.19
2$30,800-$19,260$11,5400.8573$9,893.69
3$30,800-$19,260$11,5400.7938$9,160.82
4$30,800-$19,260$11,5400.7350$8,482.24
5$30,800-$19,260$11,5400.6806$7,853.93
6$30,800-$19,260$11,5400.6302$7,272.16
7$30,800-$19,260$11,5400.5835$6,733.48
8$30,800-$19,260$11,5400.5403$6,234.7
9$30,800-$19,260$11,5400.5002$5,772.87
10$30,800-$19,260$11,5400.4632$5,345.25
NPV$15,434.34
IRR13.25%
Revenue 10% lower and cost 10% lower
YearInvestmentRevenuecostNet cash flowPv @8%Present Value
0-$62,000$0-$62,0001-$62,000
1$25,200-$16,200$9,0000.9259$8,333.33
2$25,200-$16,200$9,0000.8573$7,716.05
3$25,200-$16,200$9,0000.7938$7,144.49
4$25,200-$16,200$9,0000.7350$6,615.27
5$25,200-$16,200$9,0000.6806$6,125.25
6$25,200-$16,200$9,0000.6302$5,671.53
7$25,200-$16,200$9,0000.5835$5,251.41
8$25,200-$16,200$9,0000.5403$4,862.42
9$25,200-$16,200$9,0000.5002$4,502.24
10$25,200-$16,200$9,0000.4632$4,168.74
NPV-$1,609.27
IRR7.42%
The company can make investment when revenue increased by10% and cost increased by 7% because NPV is positive and IRR is more than cost of capital.In case of revenue lowers by 10% and cost decreased by 10% its not feasible for company to invest as NPV is negative.
4)
SituationNPVIRRRecommended
Initial stage$5,100.819.79%yes
Revenue increased by 10%$23,889.0415.94%yes
Revenue decreased by 10%-$13,687.412.82%no
Revenue increased by 10% and cost increased by 7%$15,434.3413.25%yes
Revenue decreased by 10% and cost decreased by 10%-$1,609.277.42%no
The best situation among these is revenue increased by 10% as it has highest NPV and IRR.