You have been hired as a project management consultant to assist the Acme Company in evaluating two different project proposals they are considering. Proposal A calls for the construction of a new plant which will require three years to complete and will have much greater capacity than the old plant. Because the plant will have to be built on the current site, the old plant will have to be razed. Proposal B involves the renovation of this plant. This renovation will require two years to complete, but the plant can remain in operation in a reduced capacity during this upgrade. Once the renovation is complete revenue will be increased by 25% per year, however annual maintenance will be 50% higher than Proposal A.
Proposal B: Renovate Existing Plant
Year1 Year2 Year3 Year4 Year5 Year6 Year7 Year8 Year9 Year10
Revenue 100 100 350 350 350 350 350 350 350 350
Expense 500 500 75 75 75 75 75 75 75 75
a. What is the profit associated with the project carried out in Proposal A? Proposal B?
b. When does payback occur on the project carried out in Proposal A? Proposal B?
c. What is the present value of revenue for the project carried out in Proposal A? Proposal B? (In computing present value, do not discount the value for the first year being examined.) (Assume i = 0.10)
d. What is the present value of expense for the project carried out in Proposal A? Proposal B? (In computing present value, do not discount the value for the first year being examined.) (Assume i = 0.10)
e. What is net present value for the project described in Proposal A? Proposal B? (In computing present value, do not discount the value for the first year being examined.) (Assume i = 0.10)
f. What is the internal rate of return for the project described in Proposal A? Proposal B?
g. Which project would you recommend? Why? What are the merits? What are the risks