You recently went to work for Allied Components Company, a supplier of auto repair parts used in the after-market with p

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You recently went to work for Allied Components Company, asupplier of auto repair parts used in the after-market withproducts from Daimler, Chrysler, Ford, and other automakers. Yourboss, the chief financial officer (CFO), has just handed you theestimated cash flows for two proposed projects. Project L involvesadding a new item to the firm’s ignition system line; it would takesome time to build up the market for this product, so the cashinflows would increase over time. Project S involves an add-on toan existing line, and its cash flows would decrease over time. Bothprojects have 3-year lives because Allied is planning to introduceentirely new models after 3 years.
Here are the projects’ net cash flows (in thousands ofdollars):
Year
Project L
Project S
0 (Initial Investment)
-$100
-$100
1
$10
$70
2
$60
$50
3
$80
$20
Depreciation, salvage values, net working capital requirements,and tax effects are all included in these cash flows.
The CFO also made subjective risk assessments of each project,and he concluded that both projects have risk characteristics thatare similar to the firm’s average project.Allied’s cost of capital/discount rate (r) is10%.
Task 2: Calculate Each Project’s NPV usingthe NPV formula. If you are required to accept one project out ofthese two projects, which one should you accept and why?