Chapter A, Problem 18P

Sensitivity Analysis in Capital Investment Decisions

Square Manufacturing is considering investing in a robotics manufacturing line. Installation of the line will cost an estimated $9 million. This amount must be paid immediately even though construction will take three years to complete (years 0, 1, and 2). Year 3 will be spent testing the production line and, hence, it will not yield any positive cash flows. If the operation is very successful, the company can expect after-tax cash savings of $6 million per year in each of years 4 through 7. After reviewing the use of these systems with the management of other companies, Square’s controller has concluded that the operation will most probably result in annual savings of $4.2 million per year for each of years 4 through 7. However, it is entirely possible that the savings could be as low as $1.8 million per year for each of years 4 through 7. The company uses a 14 percent discount rate.

Required

Compute the NPV under the three scenarios.