Decision Making and Capital Budgeting Project

Based on the following information, calculate net present value (NPV), internal rate of return (IRR), and payback for the investment opportunity:

  • EEC expects to save $500,000 per year for the next 10 years by purchasing the supplier.
  • EEC’s cost of capital is 14%.
  • EEC believes it can purchase the supplier for $2 million.

Answer the following:

  • Based on your calculations, should EEC acquire the supplier? Why or why not?
  • Which of the techniques (NPV, IRR, or payback period) is the most useful tool to use? Why?
  • Which of the techniques (NPV, IRR, or payback period) is the least useful tool to use? Why?
  • Would your answer be the same if EEC’s cost of capital were 25%? Why or why not?
  • Would your answer be the same if EEC did not save $500,000 per year as anticipated?
  • What would be the least amount of savings that would make this investment attractive to EEC?
  • Given this scenario, what is the most EEC would be willing to pay for the supplier?

Prepare a memo to the President of EEC that details your findings and shows the effects if any of the following situations are true:

  • EEC’s cost of capital increases.
  • The expected savings are less than $500,000 per year.
  • EEC must pay more than $2 million for the supplier.

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