Ramirez Construction is considering two new investment projects. Project EM call
ID: 2766915 • Letter: R
Question
Ramirez Construction is considering two new investment projects. Project EM calls for the purchase of certain Earthmoving Equipment, while Project HL represents an investment in a determined number of Hydraulic Lifts. Jorge Ramirez, Financial Director usually uses the Discounted Payback, The Net Present Value (NPV), The Internal Revenue Rate (I.R.R.), and the Modified Internal Revenue Rate (M.I.R.R.) for assessments of new investment projects. He occasionally, uses the Profitability Index when the projects are mutually exclusive. The initial investment and inflow cash patterns for each project are as follows:
The Weighted Average Cost of Capital of the company is 9.75% (W.A.C.C.) accordingly with the financial structure required to accomplish the investments projects. The company uses a Discounted Payback Period (D.P.P) of 10 years as acceptance criteria for this kind of investment projects.
a) Determine the Discounted Payback Period (D.P.P.) for each investment project. Use the Excel function PV to compute the present value of each flow. Then accumulate the discounted cash flow until they cover the original investment.
b) Determine the Net Present Value of each project for the following discount rates 0.00%, 9.75%, 12.00%, 15.00%, 18.00%, 20.00%. Use the Excel function for NPV.
c) Compute the Internal Rate of Return for each Project using the Excel formula for I.R.R.
d) Determine the M.I.R.R. using the corresponding Excel formula. Use the company´s weighted average capital cost as the reinvestment rate asked by Excel.
e) Draw a graphic of the Net Present Value for both projects “Projects Net Present Value Profiles using all the discount rates assigned in question “b”. Find the crossover rate. (Fisher crossover rate)
f) If the two projects were not mutually exclusive, what would your acceptance or rejection decision be accordingly with each of the financial tools used to assess the profitability of the company´s projects?
g) If the two projects were mutually exclusive, that is, the selection of one precludes the selection of the other, what would be your decision if the cost of capital were 0.00%, 9.75%, 12.00%, 15.00%, 18.00%, 20.00%. Use the net present value profile for your answer.
Explanation / Answer
Discounted Payback Period = A + (B / C)
Where,
A = Last period with a negative discounted cumulative cash flow;
B = Absolute value of discounted cumulative cash flow at the end of the period A;
C = Discounted cash flow during the period after A.
Project EM:
Discounted Payback Period = 7 + ($399,042 / $438,758)
Discounted Payback Period = 7.9 years approximately
Project EM
Year
Cash flow
PVF @ 9.75%
Discounted Cash low
Cumulative Discounted cash flow
0
(3,650,000)
0.9112
(3,325,740)
(3,325,740)
1
427,000
0.8302
354,502
(2,971,238)
2
515,000
0.7565
389,577
(2,581,661)
3
628,000
0.6893
432,854
(2,148,807)
4
695,000
0.6280
436,478
(1,712,329)
5
748,000
0.5722
428,030
(1,284,299)
6
849,200
0.5214
442,770
(841,529)
7
931,400
0.4751
442,486
(399,042)
8
1,013,600
0.4329
438,759
39,717
9
1,095,800
0.3944
432,201
471,918
10
1,178,000
0.3594
423,346
895,264
Project HL:
Discounted Payback Period = 6 + ($237032 / $332,553)
Discounted Payback Period = 6.7 years approximately
Project HL
Year
Cash flow
PVF @ 9.75%
Discounted Cash low
Cumulative Discounted cash flow
0
(4,280,000)
0.9112
(3,899,772)
(3,899,772)
1
1,110,000
0.8302
921,539
(2,978,233)
2
1,000,000
0.7565
756,461
(2,221,772)
3
900,000
0.6893
620,332
(1,601,440)
4
850,000
0.6280
533,822
(1,067,618)
5
800,000
0.5722
457,786
(609,832)
6
715,000
0.5214
372,799
(237,033)
7
700,000
0.4751
332,554
95,521
8
680,000
0.4329
294,353
389,874
9
520,000
0.3944
205,096
594,970
10
428,000
0.3594
153,813
748,783
Project EM
Year
Cash flow
PVF @ 9.75%
Discounted Cash low
Cumulative Discounted cash flow
0
(3,650,000)
0.9112
(3,325,740)
(3,325,740)
1
427,000
0.8302
354,502
(2,971,238)
2
515,000
0.7565
389,577
(2,581,661)
3
628,000
0.6893
432,854
(2,148,807)
4
695,000
0.6280
436,478
(1,712,329)
5
748,000
0.5722
428,030
(1,284,299)
6
849,200
0.5214
442,770
(841,529)
7
931,400
0.4751
442,486
(399,042)
8
1,013,600
0.4329
438,759
39,717
9
1,095,800
0.3944
432,201
471,918
10
1,178,000
0.3594
423,346
895,264
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