Problem: Wheatstone Manufacturing normally spends $500,000 for each year on regularly scheduled preventive maintenance for the equipment on its production line. But, the recent downturn in economy has forced Wheatstone to consider forgoing preventive maintenance throughout each of the next 3 years. If Wheatstone forgoes preventive maintenance over the next 3 years, the firm will need to spend $2 million at date 4 to replace equipment which has prematurely reached the end of its economic life. Estimate the IRR for the decision to postpone preventive maintenance and concisely discuss the situations under postponing maintenance is a desirable short-run financial policy for Wheatstone.
Problem: The CFO for the Stockton Company is considering proposals to invest in two mutually exclusive projects. Project A, which needs an immediate investment of $10,000, will make cash inflows of $5047 at the end of each of the next three years. Project B also needs an initial investment of $10,000. But, project B will generate perpetual yearend cash inflows of $2200. B.B. thinks that project A is superior to project B, because project A has an IRR of 24 percent whereas the IRR for project B is only 22 percent.
i) Supposing that the opportunity cost of capital is 12 percent, which project must the Stockton Company invest in?
ii) Does your decision in part (a) change if B.B. supposes that project A can be replicated (with the same prospective costs and benefits) at the end of the third year and every three years thereafter for the period of indefinite length?