Start with the partial model in the file Ch10 P23 Build a Model.xls on the textb

Question

Start with the partial model in the file Ch10 P23 Build a Model.xls on the textbook’ s

Web site. Gardial Fisheries is considering two mutually exclusive investments. The

projects’ expected net cash flows are as follows:

Expected Net Cash Flows

Year 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 12%, which project should be selected? If the

cost of capital is 18%, what project is the proper choice?

b. Construct NPV profiles for Projects A and B.

c. What is each project’ s IRR?

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

e. What is each project’ s MIRR at a cost of capital of 12%? At r = 18%?

(Hint: Consider Period 7 as the end of Project B’ s life.)

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

g. At a cost of capital of 12%, what is the discounted payback period for these two

projects?

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

is 12%?

Explanation / Answer

1. NPV(A) = -200 + 80/(1.11) + 80/(1.11)^2 + 80/(1.11)^3 + 80/(1.11)^4 = 48.19
NPV(B) = -200 + 100/(1.11) + 100/(1.11)^2 + 100/(1.11)^3 = 44.37

both of the projects are feasible and worth pursuing.

2. If you have to select one, select the one with the higher NPV, so A

3. Repeat the calculations with 0.16 instead of 0.11
NPV(A) = 23.85
NPV(B) = 24.59
now you would choose B because it pays back faster and is more advantegous at a higher discount rate

4. IRR is the discount rate that makes the project break-even, i.e. solve for r such that NPV=0
IRR(A) = 21.86%
IRR(B) = 23.375%

5. Not necessarily, see that project A had a higher NPV when r=11% and project B had a higher NPV when r=16%. It doesn't only depend on IRR

6. PIR(A) = 48.19/200 = 24.1%
PIR(B) = 44.37/200 = 22.19%
Yes it does, because the initial investments are the same. (When initial investments are different, the project with higher NPV may be ranked later because it requires a higher initial investment.)

7. Payback period for A
2 + (200-160)/80 = 2.5 years
Payback period for B is exactly 2 years.
Payback period method advises you to choose the project with the shorter payback period.

8. No, because the payback period doesn't take the time value of money into account.

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