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.
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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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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