Capital Budgeting Criteria A company has an 11% WACC and is considering two mutu

Question

Capital Budgeting Criteria A company has an 11% WACC and is considering two mutually exclusive investments (that cannot be repeated) with the following cash flows.

Project a -$300 -$387 -$193 -$100 $600 $600 $850 -$180

Project b -$405 $134 $134 $134 $134 $134 $134 $0

a. What is each projects NPV

b. What is each projects IRR

c. What is each projects MIRR?(consider project 7 as the end of project b’s life)

d. From your answers to parts a b and c, which project would be selected? If the WACC was 18%, which project would be selected?

e. Construct NPV profiles for Projects A and B

f. Calculate the crossover rate where the two projects NPV’s are equal

g. What is each project’s MIRR at a WACC of 18%?

Explanation / Answer

NPV, IRR and MIRR can be calculated using the same function in excel

For A, NPV = NPV(11%, -387...-180) -300 = $240.64 and similarly for B, NPV = $161.89

For A, IRR = IRR(-300...-180) = 18.10% and for B, IRR = 23.97%

For A, MIRR = MIRR(-300...-180, 11%, 11%) = 14.59% and for B, MIRR = 16.46%

We would select Project A as it has higher NPV than Project B.

If WACC = 18%, NPV (A) = 2.66 and NPV (B) = 63.68. Now, we will select Project B over A.

Crossover rate is the rate at which the NPV of two projects are equal and can be calculated by computing the IRR of the difference in the cash flows

Crossover rate = IRR(-105,...180) = 9.80%

At 18%, MIRR (A) = 18.05% and MIRR (B) = 20.49%

Year A B B - A 0 -300 -405 -105 1 -387 134 521 2 -193 134 327 3 -100 134 234 4 600 134 -466 5 600 134 -466 6 850 134 -716 7 -180 0 180 NPV (11%) $240.64 $161.89 IRR 18.10% 23.97% 9.80% MIRR (11%) 14.59% 16.46% NPV (18%) $2.66 $63.68 MIRR (18%) 18.05% 20.49%

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