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.