Question

California Mining is evaluating the introduction of new ore production process. Two alternatives are available, Production Process A has an initial cost of $25,000, a 4-year life, and a $5,000 net salvage value, and the use of Process A will increase net cash flow by $13,000 per year for each of the 4 years that the equipment is in use. Production Process B also requires an initial investment of $25,000, will also last 4 years, and its expected net salvage value is zero, but Process B will increase net cash flow by $15, 247 per year. Management believes that a risk adjusted discount rate of 12 percent should be used for Process A. If California Mining is to be indifferent (same NPV for Process A and B) between the two processes, what risk-adjusted discount rate must be used to evaluate B?

Answer 1

A: inputs: CF0 = -25000; CF1 = 13000; Nj = 3; CF2 = 18000; I = 12
Output: NPVA = 17663.13

B: Inputs: CF0 = -42663.13 (-25,000 + -17,663.13); CF1 = 15247; Nj = 4
Output: IRR = 16.0% = K.