Chapter:

10

Problem:

23

Gardial Fisheries is considering two mutually exclusive investments. The projects' expected net cash flows are as follows:

Expected Net Cash Flows

Time

Project A

Project B

0

($375)

($575)

1

($300)

$190

2

($200)

$190

3

($100)

$190

4

$600

$190

5

$600

$190

6

$926

$190

7

($200)

$0

a. If each project's cost of capital is 11%, which project should be selected? If the cost of capital is 17%, what project is the proper choice?

@ 11% cost of capital

@ 17% cost of capital

Use Excel's NPV function as explained in this chapter's Tool Kit. Note that the range does not include the costs, which are added separately.

WACC =

11%

WACC =

17%

NPV _A =

NPV _A =

NPV _B =

NPV _B =

b. Construct NPV profiles for Projects A and B.

Before we can graph the NPV profiles for these projects, we must create a data table of project NPVs relative to differing costs of capital.

Project A

Project B

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

24%

26%

28%

30%

c. What is each project's IRR?

We find the internal rate of return with Excel's IRR function:

IRR _A =

Note in the graph above that the X-axis intercepts are equal to the two projects' IRRs.

IRR _B =

d. What is the crossover rate, and what is its significance?

Cash flow

Time

differential

0

1

2

Crossover rate =

3

4

The crossover rate represents the cost of capital at which the two projects' NPV is equal to:

5

6

7

e. What is each project's MIRR at a cost of capital of 11%? At r = 17%? Hint: note that B is a 6-year project.

@ 11% cost of capital

@ 17% cost of capital

MIRR _A =

MIRR _A =

MIRR _B =

MIRR _B =

f. What is the regular payback period for these two projects?

Project A

Time period

0

1

2

3

4

5

6

7

Cash flow

-375

-300

-200

-100

600

$600

$926

($200)

Cumulative cash flow

Payback

Project B

Time period

0

1

2

3

4

5

6

7

Cash flow

-575

190

190

190

190

$190

$190

$0

Cumulative cash flow

Payback

g. At a cost of capital of 11%, what is the discounted payback period for these two projects?

WACC =

11%

Project A

Time period

0

1

2

3

4

5

6

7

Cash flow

-375

-300

-200

-100

600

$600

$926

($200)

Disc. cash flow

Disc. cum. cash flow

Discounted Payback

Project B

Time period

0

1

2

3

4

5

6

7

Cash flow

-575

190

190

190

190

$190

$190

$0

Disc. cash flow

Disc. cum. cash flow

Discounted Payback

h. What is the profitability index for each project if the cost of capital is 11%?

PV of future cash flows for A:

PI of A:

PV of future cash flows for B:

PI of B: