Bones Noise Cancellation Technologies has four independent projects under consid

Question

Bones Noise Cancellation Technologies has four independent projects under consideration each with a required rate of return of 10%. The total projects budget is only $2,450 (all amounts in $000). Project X has an initial investment of $2,200 and a two year cash flow of $2,360 in year 1 and $875 in year 2. Project Y has an initial investment of $1,000 and a two year cash flow cash flow in year one of $1,400 and ($200) in year 2. Project Z has an initial investment of $1,300 and a cash flow in year one of $1,570 and ($300) in year 2. Project Squeeze has an initial investment of $1,250 and a two year cash flow of $1200 and $900 in years 1 and 2 respectively. Calculate the NPV for each of these projects. If we assume that we cannot "repeat" these projects which project or combination of projects should the firm undertake? NOTE that your total investment cannot exceed $2,450 and management policy is to select investments based on highest NPV.

Invest in Project Y Only

Continuing with Bones Noise Cancellation Technologies what project or combination of projects should management invest in if the decision were based only on IRR rather than NPV.

Explanation / Answer

NPV Rule:

X:
NPV
=-2200+2360/1.1+875/1.1^2=668.5950413
Y:
NPV
=-1000+1400/1.1-200/1.1^2=107.4380165
Z:
NPV
=-1300+1570/1.1-300/1.1^2=-120.661157
Squeeze:
NPV
=-1250+1200/1.1+900/1.1^2=584.7107438

Invest in Project Y and Squeeze

IRR Rule:
Squeeze vs Y:
0=-250-200/(1+IRR)+1100/(1+IRR)^2
=>IRR=73.542%

Z vs Squeeze:
0=-50+370/(1+IRR)-1200/(1+IRR)^2

X vs Squeeze:
0=-950+1160/(1+IRR)-25/(1+IRR)^2
=>IRR=19.911%

Invest in Project X only

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