Textbook Problem

Patterson Company is considering two competing investments. The first is for a standard piece of production equipment. The second is for computer-aided manufacturing (CAM) equipment. The investment and after-tax operating cash flows follow:

Patterson uses a discount rate of 18% for all of its investments. Patterson’s cost of capital is 10%.

Fabre Company, Patterson Company’s competitor, is considering the same investments as Patterson. Refer to the data in Problem 12-52 above. Assume that Fabre’s cost of capital is 14%.

Required:

1. 1. Calculate the NPV of each alternative by using the 14% rate.
2. 2. CONCEPTUAL CONNECTION Now assume that if the standard equipment is purchased, the competitive position of the firm will deteriorate because of lower quality (relative to competitors who did automate). Marketing estimates that the loss in market share will decrease the projected net cash inflows by 50% for Years 3 through 10. Recalculate the NPV of the standard equipment given this outcome. What is the decision now? Discuss the importance of assessing the effect of intangible benefits.