Facebook is considering two proposals to overhaul its network infrastructure. They have received two bids. The first bid from Huawei will require a $23 million upfront investment and will generate $20 million in savings for Facebook each year for the next 3 years. The second bid from Cisco requires a $100 million upfront investment and will generate $60 million in savings each year for the next 3 years. a. What is the IRR for Facebook associated with each bid? b. If the cost of capital for each investment is 10%, what is the net present value (NPV) for Facebook of each bid? Suppose Cisco modifies its bid by offering a lease contract instead. Under the terms of the lease, Facebook will pay $28 million up front, and $35 million per year for the next 3 years. Facebook's savings will be the same as with Cisco's original bid. c. Including its savings, what are Facebook's net cash flow under the lease contract? What is the IRR of the Cisco bid now? d. Is this new bid a better deal for Facebook than Cisco's original bid? Explain.
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
Facebook is considering two proposals to overhaul its network infrastructure. They have received two bids. The first bid from Huawei will require a $23 million upfront investment and will generate $20 million in savings for Facebook each year for the next 3 years. The second bid from Cisco requires a $100 million upfront investment and will generate $60 million in savings each year for the next 3 years.
a. What is the IRR for Facebook associated with each bid?
b. If the cost of capital for each investment is 10%, what is the
c. Including its savings, what are Facebook's net cash flow under the lease contract? What is the IRR of the Cisco bid now?
d. Is this new bid a better deal for Facebook than Cisco's original bid? Explain.
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