Case One (22 pts) Ferengi, Inc. is subject to an applicable corporate tax rate of 21...

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Case One (22 pts) Ferengi, Inc. is subject to an applicablecorporate tax rate of 21 percent, and the weighted average cost ofcapital (WACC) of 12.5 percent. There is no specific timeconstraint on investment project payback requirements.
Q1: Ferengi is currently contemplating two capital investmentplans. Plan A: the upgrade of an information system with aninstalled cost of $2,400,000. The upgrade system will bedepreciated straight-line to zero over the project’s five-yearlife, at the end of which the system will be worth $400,000 at themarket. The system upgrade will not affect sales, but will save thefirm $700,000 per year in pretax operating costs; and the upgradewill increase the working efficiency and reduce the net workingcapital expenditure by $300,000 at the beginning year.
What is the NPV of Plan A? What is the IRR of Plan A? ShouldFerengi accept or reject Plan A?
Q2: Instead of Plan A, Ferengi can alternatively choose Plan B:allocate the $2,400,000 capital budget to develop a new productline. The new product line will be depreciated straight-line tozero over the project’s ten-year life, at the end of which thesystem will be worth $100,000. The new product line will not onlyadd the firm $830,000 per year in sales, but also add $200,000 peryear in pretax operating costs; and the new project line requiresan initial investment in net working capital of $300,000 at thebeginning year.
What would be the NPV of Plan B? What would be the IRR of PlanB? If these two plans are mutually exclusive, shall Ferengi finallychoose Plan A or B?

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3.5 Ratings (603 Votes)

1Project Cash flows year 0 installed cost reduction in working capitalYears 1 to 4 Increase in EBIT taxes depreciationYear 5 Increase in See Answer

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Case One (22 pts) Ferengi, Inc. is subject to an applicablecorporate tax rate of 21 percent, and the weighted average cost ofcapital (WACC) of 12.5 percent. There is no specific timeconstraint on investment project payback requirements.Q1: Ferengi is currently contemplating two capital investmentplans. Plan A: the upgrade of an information system with aninstalled cost of $2,400,000. The upgrade system will bedepreciated straight-line to zero over the project’s five-yearlife, at the end of which the system will be worth $400,000 at themarket. The system upgrade will not affect sales, but will save thefirm $700,000 per year in pretax operating costs; and the upgradewill increase the working efficiency and reduce the net workingcapital expenditure by $300,000 at the beginning year.What is the NPV of Plan A? What is the IRR of Plan A? ShouldFerengi accept or reject Plan A?Q2: Instead of Plan A, Ferengi can alternatively choose Plan B:allocate the $2,400,000 capital budget to develop a new productline. The new product line will be depreciated straight-line tozero over the project’s ten-year life, at the end of which thesystem will be worth $100,000. The new product line will not onlyadd the firm $830,000 per year in sales, but also add $200,000 peryear in pretax operating costs; and the new project line requiresan initial investment in net working capital of $300,000 at thebeginning year.What would be the NPV of Plan B? What would be the IRR of PlanB? If these two plans are mutually exclusive, shall Ferengi finallychoose Plan A or B?