Kim Inc. must install a new air conditioning unit in its main plant. Kim must install one or the other of the units; otherwise the highly profitable plant would have to shut down. Two units are available, HCC and LCC (for high and low capital costs). HCC has a high capital cost but relatively low operating costs, while LCC has a low capital cost but higher operating costs because it uses more electricity. The costs of the units are shown below. Kim’s WACC is 7%. Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 HCC -$600,000 -$50,000 -$50,000 -$50,000 -$50,000 -$50,000 LCC -$100,000 -$175,000 -$175,000 -$175,000 -$175,000 -$175,000 a) Which unit would you recommend? Explain. b) If Kim’s controller wanted to know the IRRs of the two projects, what would you tell him? c) If the WACC rose to 15% would this affect your recommendation? Explain your answer and the reason this result occurred.
Kim Inc. must install a new air conditioning unit in its main plant. Kim must install one or the other of the units; otherwise the highly profitable plant would have to shut down. Two units are available, HCC and LCC (for high and low capital costs). HCC has a high capital cost but relatively low operating costs, while LCC has a low capital cost but higher operating costs because it uses more electricity. The costs of the units are shown below. Kim’s WACC is 7%. Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 HCC -$600,000 -$50,000 -$50,000 -$50,000 -$50,000 -$50,000 LCC -$100,000 -$175,000 -$175,000 -$175,000 -$175,000 -$175,000 a) Which unit would you recommend? Explain. b) If Kim’s controller wanted to know the IRRs of the two projects, what would you tell him? c) If the WACC rose to 15% would this affect your recommendation? Explain your answer and the reason this result occurred.
Intermediate Financial Management (MindTap Course List)
13th Edition
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Eugene F. Brigham, Phillip R. Daves
Chapter12: Capital Budgeting: Decision Criteria
Section: Chapter Questions
Problem 20P: The Aubey Coffee Company is evaluating the within-plant distribution system for its new roasting,...
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Kim Inc. must install a new air conditioning unit in its main plant. Kim must install one or the other of the units; otherwise the highly profitable plant would have to shut down. Two units are available, HCC and LCC (for high and low capital costs). HCC has a high capital cost but relatively low operating costs, while LCC has a low capital cost but higher operating costs because it uses more electricity. The costs of the units are shown below. Kim’s WACC is 7%.
|
Year 0 |
Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
HCC |
-$600,000 |
-$50,000 |
-$50,000 |
-$50,000 |
-$50,000 |
-$50,000 |
LCC |
-$100,000 |
-$175,000 |
-$175,000 |
-$175,000 |
-$175,000 |
-$175,000 |
- a) Which unit would you recommend? Explain.
- b) If Kim’s controller wanted to know the
IRRs of the two projects, what would you tell him? - c) If the WACC rose to 15% would this affect your recommendation? Explain your answer and the reason this result occurred.
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