Question 2 (evaluating investment projects)

Question 2 (evaluating investment projects)

General Motors (or Toyota) is thinking of investing in new production equipment, which will cost $400 million in year zero, and will generate cost savings of $240
million in year 1, $160 million in year 2, and $120 million in year 3. After 3 years, the salvage value is zero. The cost of capital (discount rate) is 25% for
General Motors and 10% for Toyota. (Due to GM’s recent bankruptcy, investors are scared to lend it money, so GM has to pay much higher interest rates to attract
capital).

Required:

a) What’s the NPV of this project for General Motors?
NPV = $_________________ million (If you get say $3.52 million, enter 3.52 not 3,520,000. If you get a negative number, enter it with a minus sign, i.e., -3.52 not
(3.52))
Should GM invest, based on NPV? (1=yes, 2=no) ______________

b) What’s the NPV of this project for Toyota?
NPV = $ _____________ million
Should Toyota invest, based on NPV? (1=yes, 2=no) _______________

c) If you computed (a) and (b) correctly, the decisions for GM and Toyota should be different. Briefly explain why they are different.

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