Chapter: 10 Problem: 23 Build a Model

| November 9, 2018

12/7/2012 Chapter: 10 Problem: 23 Gardial Fisheries is considering two mutually exclusive investments. The projects’ expected net cash flows are as follows: Expected Net Cash Flows Time 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? @ 12% cost of capital @ 18% cost of capital Use Excel’s NPV function as explained in this chapter’s Tool Kit. Note that the range does not include the costs, which are added separately. WACC = 12% WACC = 18% NPV A = NPV A = NPV B = NPV B = At a cost of capital of 12%, Project A should be selected. However, if the cost of capital rises to 18%, then the choice is reversed, and Project B should be accepted. b. Construct NPV profiles for Projects A and B. Before we can graph the NPV profiles for these projects, we must create a data table of project NPVs relative to differing costs of capital. Project A Project B 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 22% 24% 26% 28% 30% c. What is each project’s IRR? We find the internal rate of return with Excel’s IRR function: IRR A = Note in the graph above that the X-axis intercepts are equal to the two projects’ IRRs. IRR B = d. What is the crossover rate, and what is its significance? Cash flow Time differential 0 1 2 Crossover rate = 3 4 “The crossover rate represents the cost of capital at which the two projects value, at a cost of capital of 13.14% is:have the same net present value. In this scenario, that common net present” 5 6 7 e. What is each project’s MIRR at a cost of capital of 12%? At r = 18%? Hint: note that B is a 6-year project. @ 12% cost of capital @ 18% cost of capital MIRR A = MIRR A = MIRR B = MIRR B = f. What is the regular payback period for these two projects? Project A Time period 0 1 2 3 4 5 6 7 Cash flow (375) (300) (200) (100) 600 $600 $926 ($200) Cumulative cash flow Payback Project B Time period 0 1 2 3 4 5 6 7 Cash flow (575) 190 190 190 190 $190 $190 $0 Cumulative cash flow Payback g. At a cost of capital of 12%, what is the discounted payback period for these two projects? WACC = 12% Project A Time period 0 1 2 3 4 5 6 7 Cash flow (375) (300) (200) (100) 600 $600 $926 ($200) Disc. cash flow Disc. cum. cash flow Discounted Payback Project B Time period 0 1 2 3 4 5 6 7 Cash flow (575) 190 190 190 190 $190 $190 $0 Disc. cash flow Disc. cum. cash flow Discounted Payback h. What is the profitability index for each project if the cost of capital is 12%? PV of future cash flows for A: PI of A: PV of future cash flows for B: PI of B:

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