QUESTION

# A company is considering two alternative expansion plans. The first plan will result in capital expenditures of \$8,450,000.

A company is considering two alternative expansion plans. The first plan will result in capital expenditures of \$8,450,000. The capital expenditure will provide equipment with a useful life of 8 years and \$0 salvage value at the end of its useful life. This plan will produce annual net cash inflows of \$1,750,000.

The second plan will result in capital expenditures of \$8,000,000. The capital expenditure will provide equipment with a useful life of 8 years and \$1,200,000 salvage value at the end of its useful life. This plan will produce annual net cash inflows of \$1,020,000.

The company uses the straight-line depreciation methods for determining depreciation expense. The only difference between cash inflows and net income are related to the depreciation expense on the equipment. The company requires an annual rate of return equal to 6% for its capital investment decisions.

Required

1.      Compute the payback period for each of the two alternatives.

2.      Compute the net present value for each of the two alternatives.

3.      Determine the internal rate of return for each of the two alternatives.

4.      Which expansion plan do you recommend that the company pursue based on the results of your calculations?