# NPV, IRR, MIRR, Payback period

See attached file.

SAC is considering the purchase of new equipment to manufacture specialty spark plugs. The new equipment would allow the firm to manufacture 100,000 additional spark plugs per year and is expected to have a useful life of 5 years and to have no salvage value at that time. SAC will depreciate the equipment using the straight-line method. Specialty spark plugs are selling for an average price of $20 and are expected to cost $8 to manufacture with the new equipment. Indirect costs are expected to remain the same. The equipment will cost $3,000,000 to purchase and install. SAC's tax rate is 34%.

The company has the following capital structure and intends to keep its capital structure intact in financing this equipment. Use appropriate analytical tools to determine if SAC should purchase the new equipment. Describe how you arrived at your recommendation and show your work.

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#### Solution Preview

See attached Excel file.

SAC is considering the purchase of new equipment to manufacture specialty spark plugs. The new equipment would allow the firm to manufacture 100,000 additional spark plugs per year and is expected to have a useful life of 5 years and to have no salvage value at that time. SAC will depreciate the equipment using the straight-line method. Specialty spark plugs are selling for an average price of $20 and are expected to cost $8 to manufacture with the new equipment. Indirect costs are expected to remain the same. The equipment will cost $3,000,000 to purchase and install. SAC's tax rate is 34%.

Cost of capital represents the opportunity cost of the capital. It is weighted average cost of all the sources of funds used in the firm. Here the cost of capital is 11% as calculated in the excel file.

Capital budgeting involves taking decisions about the long term assets mix of the organization. Let us discusses each of the capital budgeting tools:

NET PRESENT VALUE:

As per investopedia "Net Present Value is the difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project. NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield. "

If a prospective investment has a positive net present value (i.e., the present value of cash inflows exceeds the present value of cash outflows), then it clears the minimum cost of capital and project can be accepted. On the other hand, if an investment has a negative net present value, the investment opportunity should be rejected.

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#### Solution Summary

Response provides steps for computing NPV, IRR, MIRR, Payback period