IRR, NPV, and Profitability Index. Consider two projects that your company is evaluating. Project A has cash flows of -25, +11, +12, and +10 at time-zero, one year from now, two years from now, and three years from now, respectively. Project B has cash flows of -50, +22.5, +21.5, and +20.5 at time-zero, one year from now, two years from now, and three years from now, respectively. For the risk of these projects, the appropriate discount rate is 10%.
What is the NPV and IRR of each project?
What is the Profitability Index (PI) of each project, where the appropriate discount rate (the cost of capital) is 10%? If you firm is subject to limited capital to invest (capital rationing), what does your PI suggest about which project you would likely prefer?
Now, alternatively, assume that these two projects are mutually exclusive such that your company can choose only one of the two projects. Should your company choose Project A or Project B?
IRR, NPV, and Profitability Index. Consider two projects that your company is evaluating. Project A has cash flows of -25, +11, +12, and +10 at time-zero, one year from now, two years from now, and three years from now, respectively. Project B has cash flows of -50, +22.5, +21.5, and +20.5 at time-zero, one year from now, two years from now, and three years from now, respectively. For the risk of these projects, the appropriate discount rate is 10%.
What is the NPV and IRR of each project?
What is the Profitability Index (PI) of each project, where the appropriate discount rate (the cost of capital) is 10%? If you firm is subject to limited capital to invest (capital rationing), what does your PI suggest about which project you would likely prefer?
Now, alternatively, assume that these two projects are mutually exclusive such that your company can choose only one of the two projects. Should your company choose Project A or Project B?
Related questions
You are a financial analyst for the Waffle Company. The director of capital budgeting has asked you to analyze two proposed capital investments, Projects A and B. Ā Each project has a cost of $50,000, and the cost of capital for each is 10%.
The projectsā expected net cash flows are as follows:
|
Ā |
Expected Net Cash Flows |
|
|
Year |
Project A |
Project B |
|
0 |
($50,000) |
($50,000) |
|
1 |
25,000 |
15,000 |
|
2 |
20,000 |
15,000 |
|
3 |
10,000 |
15,000 |
|
4 |
5,000 |
15,000 |
|
5 |
5,000 |
15,000 |
Ā
- Calculate each projectās payback period, net present value (NPV), internal rate of return (IRR), modified internal rate of return (MIRR), and profitability index (PI).
| Question: | ||||
| The Sanders Electric Company is evaluating two projects for possible inclusion in the firmĆ¢ĀĀs capital budget. Project M will require a $37,000 investment while project OĆ¢ĀĀs investment will be $46,000. After-tax cash inflows are estimated as follows for the two projects: | ||||
| Year | Project M | Project O | ||
| 1 | $12,000 | $10,000 | ||
| 2 | 12000 | 10000 | ||
| 3 | 12000 | 15000 | ||
| 4 | 12000 | 15000 | ||
| 5 | 15000 | |||
| a. | Determine the payback period for each project. | |||
| Payback (M) = | ||||
| Payback (O) = | ||||
| b. | Calculate the net present value and profitability index for each project based on a 10 percent cost of capital. Which, if either, of the project is acceptable? | |||
| NPV (M) = | ||||
| PI (M) = | ||||
| NPV (O) = | ||||
| PI (O) = | ||||
| c. | Determine the internal rate of return and modified internal rate of return for Projects M and O. | |||
| IRR (M): | ||||
| IRR (O): | ||||
| MIRR calculation of project M: | ||||
| MIRR calculation of project O: | ||||
