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Sensitivity Analysis : NPV, Profitability Index and IRR

Problem 8-41

Dunn Manufacturing Company is considering the purchase of a factory that makes valves. These valves would be used by Dunn to manufacture water pumps. The purchase would require an initial outlay of $1,564,800. The factory would have an estimated life of 10 years and no residual value. Currently, the company buys 500,000 valves per year at a cost of $1.50 each. If the factory were purchased, the valves could be manufactured for $0.90 each.

Required:

a. Determine the net present value of the proposed project and whether it should be accepted under each of the following assumptions.
1. The cost of capital is 12 percent.
2. The cost of capital is 14 percent.
3. The cost of capital is 16 percent.

b. Determine the profitability index under each of the following assumptions.

1. The cost of capital is 12 percent.
2. The cost of capital is 14 percent.
3. The cost of capital is 16 percent.

c. Determine the internal rate of return of the proposed project and indicate whether it should be accepted under each of the following assumptions.

1. The cost of capital is 12 percent.
2. The cost of capital is 14 percent.
3. The cost of capital is 16 percent.

Solution Summary

This solution illustrates how to compute the net present value, profitability index and internal rate of return under different discount rate assumptions.

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