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You recently went to work for Allied Components Company, a supplier of auto repair parts used in the after-market with products from Daimler AG, Ford, Toyota, and other automakers.

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You recently went to work for Allied Components Company, a supplier of auto repair parts used
in the after-market with products from Daimler AG, Ford, Toyota, and other automakers.
Your boss, the chief financial officer (CFO), has just handed you the estimated cash flows for two
proposed projects. Project L involves adding a new item to the firm’s ignition system line; it would
take some time to build up the market for this product, so the cash inflows would increase over
time. Project S involves an add-on to an existing line, and its cash flows would decrease over
time. Both projects have 3-year lives because Allied is planning to introduce entirely new models
after 3 years.

Here are the projects’ cash flows (in thousands of dollars):

Year CFL CFS
0 ($100) ($100)
1 $10 $70
2 $60 $50
3 $80 $20

Depreciation, salvage values, net operating working capital requirements, and tax effects are all
included in these cash flows. The CFO also made subjective risk assessments of each project,
and he concluded that both projects have risk characteristics that are similar to the firm’s average
project. Allied’s WACC is 10%. You must determine whether one or both of the projects should
be accepted.

(1) What is each project’s NPV?

WACC 10%

The solution can be found using Excel’s NPV function, which finds the NPV of CF1 to CFN, and then
add the value of CF0 to the result.

NPVL = Choose both projects if they’re independent, but if
NPVS = they’re mutually exclusive choose Project S.

(2) What is each project’s IRR?

The internal rate of return (IRR) is that discount rate which forces the NPV of a project to equal
zero.

The solution to this equation can be found using Excel’s IRR function.

IRRL = Choose both projects if they’re independent, but if
IRRS = they’re mutually exclusive choose Project S.

This is on excel.

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