Medical Technology Enterprises is trying to select the best investment from amon
ID: 2797447 • Letter: M
Question
Medical Technology Enterprises is trying to select the best investment from among four alternatives. Each alternative involves an initial outlay of $100,000. and the company’s cost of capital (WACC) is 10%. Their future cash flows follow: (See pages 383 – 390).
Year
Alternative A ($)
Alternative B (S)
Alternative C ($)
Alternative D ($)
Initial cost
-100,000
-100,000
-100,000
-100,000
1
10,000
50,000
25,000
0
2
20,000
40,000
25,000
0
3
30,000
30,000
25,000
45,000
4
40,000
0
25,000
55,000
5
50,000
0
25,000
60,000
Evaluate and rank each alternative based on (PLEASE SHOW YOUR WORK):
a) Payback period,
Alternative A: ___________________ Rank (1st, 2nd, 3rd, 4th) __________
Alternative B: ___________________ Rank (1st, 2nd, 3rd, 4th) ___________
Alternative C: ____________________ Rank (1st, 2nd, 3rd, 4th) ___________
Alternative D: ____________________ Rank (1st, 2nd, 3rd, 4th) ___________
b) Net present value (use a 10% discount rate),
Alternative A: ___________________ Rank (1st, 2nd, 3rd, 4th) __________
Alternative B: ___________________ Rank (1st, 2nd, 3rd, 4th) __________
Alternative C: ____________________ Rank (1st, 2nd, 3rd, 4th) __________
Alternative D: Rank (1st, 2nd, 3rd, 4th) __________
c) Internal rate of return.
Alternative A: ___________________ Rank (1st, 2nd, 3rd, 4th) __________
Alternative B: ___________________ Rank (1st, 2nd, 3rd, 4th) __________
Alternative C: ____________________ Rank (1st, 2nd, 3rd, 4th) __________
Alternative D: Rank (1st, 2nd, 3rd, 4th) __________
Year
Alternative A ($)
Alternative B (S)
Alternative C ($)
Alternative D ($)
Initial cost
-100,000
-100,000
-100,000
-100,000
1
10,000
50,000
25,000
0
2
20,000
40,000
25,000
0
3
30,000
30,000
25,000
45,000
4
40,000
0
25,000
55,000
5
50,000
0
25,000
60,000
Explanation / Answer
Payback of A: Happens at 4 years: -100000+10000+20000+30000+40000=0
Payback of B: Happens at 2.33 years: -100000+50000+40000+30000*0.33=0
Payback of C: Happens at 4 years: -100000+25000+25000+25000+25000=0
Payback of D: Happens at 4 years: -100000+0+0+45000+55000=0
Lower the payback better is the project hence Project B ranks 1st and all other projects are equal in rank at 2nd
Net present value of A:-100000+10000/1.1+20000/1.1^2+30000/1.1^3+40000/1.1^4+50000/1.1^5=6525.883105
Net present value of B:-100000+50000/1.1+40000/1.1^2+30000/1.1^3+0/1.1^4+0/1.1^5=1051.840721
Net present value of C:-100000+25000/1.1+25000/1.1^2+25000/1.1^3+25000/1.1^4+25000/1.1^5=-5230.330765
Net present value of D: -100000+0/1.1+0/1.1^2+45000/1.1^3+55000/1.1^4+60000/1.1^5=8630.185469
Higher the NPV better is the project hence Project D ranks 1st, Project A ranks 2nd, Project B ranks 3rd and Project C ranks 4th
IRR of A:
0=-100000+10000/(1+IRR)+20000/(1+IRR)^2+30000/(1+IRR)^3+40000/(1+IRR)^4+50000/(1+IRR)^5
=>IRR=12.058%
IRR of B:
0=-100000+50000/(1+IRR)+40000/(1+IRR)^2+30000/(1+IRR)^3+0/(1+IRR)^4+0/(1+IRR)^5
=>IRR=10.6517%
IRR of C:
0=-100000+25000/(1+IRR)+25000/(1+IRR)^2+25000/(1+IRR)^3+25000/(1+IRR)^4+25000/(1+IRR)^5
=>IRR=7.9308%
IRR of D:
0=-100000+0/(1+IRR)+0/(1+IRR)^2+45000/(1+IRR)^3+55000/(1+IRR)^4+60000/(1+IRR)^5
=>IRR=12.2857%
Higher the IRR better is the project hence Project D ranks 1st, Project A ranks 2nd, Project B ranks 3rd and Project C ranks 4th