Start with the partial model in the file Ch10 P23 Build a Model.xls on the textb
ID: 2697884 • Letter: S
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.