iane Dennison is a financial analyst working for a large chain of discount retail stores. Her company is looking at the possibility of replacing the existing fluorescent lights in all of its stores with LED lights. The main advantage of making this switch is that the LED lights are much more efficient and cost less to operate. In addition, LED lights last much longer and will have to be replaced after ten years, whereas the existing lights have to be replaced after five years. Of course, making this change will require a large investment to purchase new LED lights and to pay for the labor of switching out tens of thousands of bulbs. Diane plans to use a 10-year horizon to analyze this proposal, figuring that changes to lighting technology will eventually make this investment obsolete. Diane's friend and coworker, David, has analyzed another energy-saving investment opportunity that involves replacing outdoor lighting with solar-powered fixtures in a few of the company's stores. David also used a 10-year horizon to conduct his analysis. Cash flow forecasts for each project are given here Year LED project Solar project 0 -4,225,000 -500,000 1 700,000 61,000 2 700,000 61,000 3 700,000 61,000 4 700,000 61,000 5 1,100,000 61,000 6 700,000 61,000 7 700,000 61,000 8 700,000 61,000 9 700,000 61,000 10 700,000 61,000

Cornerstones of Cost Management (Cornerstones Series)

4th Edition

ISBN:9781305970663

Author:Don R. Hansen, Maryanne M. Mowen

Publisher:Don R. Hansen, Maryanne M. Mowen

Chapter19: Capital Investment

Section: Chapter Questions

Problem 30P: Mallette Manufacturing, Inc., produces washing machines, dryers, and dishwashers. Because of...

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Diane Dennison is a financial analyst working for a large chain of discount retail stores. Her company is looking at the possibility of replacing the existing fluorescent lights in all of its stores with LED lights. The main advantage of making this switch is that the LED lights are much more efficient and cost less to operate. In addition, LED lights last much longer and will have to be replaced after ten years, whereas the existing lights have to be replaced after five years. Of course, making this change will require a large investment to purchase new LED lights and to pay for the labor of switching out tens of thousands of bulbs. Diane plans to use a 10-year horizon to analyze this proposal, figuring that changes to lighting technology will eventually make this investment obsolete.

Diane's friend and coworker, David, has analyzed another energy-saving investment opportunity that involves replacing outdoor lighting with solar-powered fixtures in a few of the company's stores. David also used a 10-year horizon to conduct his analysis. Cash flow forecasts for each project are given here

Year	LED project	Solar project
0	-4,225,000	-500,000
1	700,000	61,000
2	700,000	61,000
3	700,000	61,000
4	700,000	61,000
5	1,100,000	61,000
6	700,000	61,000
7	700,000	61,000
8	700,000	61,000
9	700,000	61,000
10	700,000	61,000

The company uses a 10% discount rate to analyze capital budgeting proposals.

a. What is the NPV of each investment? Which investment (if either) should the company undertake?

b. David approaches Diane for a favor. David says that the solar lighting project is a pet project of his boss, and David really wants to get the project approved to curry favor with his boss. He suggests to Diane that they roll their two projects into a single proposal. The cash flows for this combined project would simply equal the sum of the two individual projects. Calculate the NPV of the combined project. Does it appear to be worth doing? Would you recommend investing in the combined project?

c. What is the ethical issue that Diane faces? Is any harm done if she does the favor for David as he asks?

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