A firm with a 13% WACC is evaluating two projects for this year\'s capital budge

Question

A firm with a 13% WACC is evaluating two projects for this year's capital budget. After-tax cash flows, including depreciation, are as follows:

Calculate NPV for each project. Round your answers to the nearest cent. Do not round your intermediate calculations.
Project M    $
Project N    $

Calculate IRR for each project. Round your answers to two decimal places. Do not round your intermediate calculations.
Project M      %
Project N      %

Calculate MIRR for each project. Round your answers to two decimal places. Do not round your intermediate calculations.
Project M      %
Project N      %

Calculate payback for each project. Round your answers to two decimal places. Do not round your intermediate calculations.
Project M      years
Project N      years

Calculate discounted payback for each project. Round your answers to two decimal places. Do not round your intermediate calculations.
Project M      years
Project N      years

Assuming the projects are independent, which one(s) would you recommend?  
-Select-Only Project M would be accepted because IRR(M) > IRR(N).Both projects would be rejected since both of their NPV's are negative.Only Project M would be accepted because NPV(M) > NPV(N).Only Project N would be accepted because NPV(N) > NPV(M).Both projects would be accepted since both of their NPV's are positive.Item 11

If the projects are mutually exclusive, which would you recommend?
-Select-If the projects are mutually exclusive, the project with the highest positive IRR is chosen. Accept Project N.If the projects are mutually exclusive, the project with the highest positive NPV is chosen. Accept Project N.If the projects are mutually exclusive, the project with the highest positive IRR is chosen. Accept Project M.If the projects are mutually exclusive, the project with the highest positive MIRR is chosen. Accept Project M.If the projects are mutually exclusive, the project with the shortest Payback Period is chosen. Accept Project M.Item 12

Notice that the projects have the same cash flow timing pattern. Why is there a conflict between NPV and IRR?
-Select-There is no conflict between NPV and IRR.The conflict between NPV and IRR occurs due to the difference in the size of the projects.The conflict between NPV and IRR is due to the relatively high discount rate.The conflict between NPV and IRR is due to the fact that the cash flows are in the form of an annuity.The conflict between NPV and IRR is due to the difference in the timing of the cash flows.Item 13

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Explanation / Answer

ANSWERS TO QUESTIONS IN THE END:

Assuming the projects are independent, which one(s) would you recommend?  
Both projects would be accepted since both of their NPV's are positive.

If the projects are mutually exclusive, which would you recommend?
If the projects are mutually exclusive, the project with the highest positive NPV is chosen. Select Project N.

NPV can be criteria, as the projects have equal lives. If the projects have unequal lives Equivalent Annual NPV would be applied.

Notice that the projects have the same cash flow timing pattern. Why is there a conflict between NPV and IRR?

The conflict between NPV and IRR occurs due to the difference in the size of the projects.

Instead of IRR, the incremental IRR would give the same decision as NPV.

1) NPV: Project M: NPV = 8000*PVIFA(13,5)-24000 = 8000*3.5172 - 24000 = $   4,137.60 Project N: NPV = 22400*PVIFA(13,5)-72000 = 22400*3.5172 - 72000 = $   6,785.28 2) IRR: IRR is that discount rate for which NPV is 0. Project M: If NPV is 0, = 8000*PVIFA(irr,5)-24000 = 0 Solving for irr 3 = PVIFA(irr,5) The PVIFA for 19% and 20% are given below: 19% 20% 3.0576 2.9906 IRR, By simple inerpolation = 19+(3.0576-3.000)/(3.0576-2.9906)= 19.86% Project N: =22400*PVIFA(irr,5)-72000 = 0 Solving for irr 3.2143 = PVIFA(irr,5) The PVIFA for 19% and 20% are given below: 16% 17% 3.2743 3.1993 IRR, By simple inerpolation = 16+(3.2743-3.2143)/(3.2743-3.1993)= 16.80% 3) MIRR: MIRR assumes that intevening cash flows would earn at WACC; hence should be compounded using WACC. Project M: FV of Cash inflows = 8000*FVIFA(13,5) = 8000*6.4803= $    51,842.40 MIRR = (51842.40/24000)^(1/5)-1 = 16.65% Project N: FV of cash inflows = 22400*6.4803 = $ 145,158.72 MIRR = (145158.72/72000)^(1/5)-1 = 15.05% 4) Payback: Project M: Payback = 24000/8000 = 3 years Project N: Payback = 72000/22400 = 3.21 years 5) DISCOUNTED PAYBACK: Project M: Year After tax cash flows PVIF at 13% PV at 13% Cumulative PV 0 -24000 1 -24000 -24000 1 8000 0.88496 7080 -16920 2 8000 0.78315 6265 -10655 3 8000 0.69305 5544 -5111 4 8000 0.61332 4907 -204 5 8000 0.54276 4342 4138 4138 Discounted payback = 4+204/4342 = 4.05 years Project N: Year After tax cash flows PVIF at 13% PV at 13% Cumulative PV 0 -72000 1 -72000 -72000 1 22400 0.88496 19823 -52177 2 22400 0.78315 17542 -34635 3 22400 0.69305 15524 -19110 4 22400 0.61332 13738 -5372 5 22400 0.54276 12158 6786 6786 Discounted payback = 4+5372/12158 = 4.44 years

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