Problem
Your client's husband is investigating the possibility of installing a new advanced computing system to improve the customer services in his company. You have been given the following information for evaluation:
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Project A
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Project B
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CAPEX / Initial Outlay
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$400,000
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$200,000
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Project life
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8 years
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5 years
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Operating Expense
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$75,000
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$100,000
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Revenue (per year)
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$300,000
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$400,000
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Variable costs
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$100,000
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$200,000
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Investment in Net Working Capital (Year 0)
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$50,000
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$100,000
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The company's tax rate is 30% and it employs a straight line depreciation method. The computing system will not have any value at the end of the project's life. The company also has a required rate of return equal to 11% per annum.
Task
A. Determine the Free Cash Flows (FCFs), for each year, to the firm for both projects.
B. Based on your calculated FCFs, calculate the Net Present Value of the project and identify which of the projects you would recommend.
C. Why can't the NPVs of unequal life, mutually exclusive projects be compared? Which method should we use instead?