Carmona & Co. is considering the implementation of the following two, mutually exclusive projects:

Project A

r = 9%

Years 0 1 2 3 4 5

CF $-3,000,000 1,100,000 1,300,000 -800,000 1,300,000 1,300,000

Project B

r=9%

Years 0 1 2 3 4 5

CF -$3,000,000 550,000 550,000 550,000 5550,000 550,000

Based on this information about project cash flows, answer the following questions:

1. Using traditional DCF analysis, what is the MIRR of Project A.
2. Using traditional DCF analysis, what is the IRR of Project B.
3. Using traditional DCF analysis, what is the expected NPV of Project A AND Project B?
   • Based on this, which project would you suggest the company take?
4. Management has reconsidered these projects and determined that Project B has the potential to create additional future investment opportunities at the end of 5 years. If Carmona and Co. goes ahead with Project B today, it will obtain knowledge that will give rise to additional opportunities 5 years from now (at t=5). The company can decide at t=5 whether or not it wants to pursue these additional opportunities.
   • Based on the best information available today, there is a 35% probability that the outlook will be favorable, in which case the future investment opportunity will have a net present value of $6 million at t=5.
   • There is a 65% probability that the outlook will be unfavorable in which case the future investment opportunity will have to decide today whether it wants to pursue the additional opportunity. Instead, it can wait to see what the outlook is and either invest (if the outlook is good) or not pursue the additional opportunities (if the outlook is bad). However, the company cannot pursue the future opportunity unless it makes the $3 million investment today. What is the estimated net present value of the project, after consideration of the potential future opportunity.
5. Based on the inclusion of the real option into the analysis of Project B, would you suggest Project A or Project B to the firm?

Answer rating: 100% (QA)

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