A firm with a 13% WACC is evaluating two projects for this year\'s capital budge

Question

A firm with a 13% WACC is evaluating two projects for this year's capital budget. After-tax cash flows, including depreciation, are as follows:

                      0          1           2           3          4           5

Project A -$3,000 $1,000 $1,000 $1,000 $1,000 $1,000

Project B -$9,000 $2,800 $2,800 $2,800 $2,800 $2,800

a. Calculate NPV for each project. Round your answers to the nearest cent.

Project A $

Project B $

Calculate IRR for each project. Round your answers to two decimal places.

Project A %

Project B %

Calculate MIRR for each project. Round your answers to two decimal places.

Project A %

Project B %

Calculate payback for each project. Round your answers to two decimal places.

Project A years

Project B years

Calculate discounted payback for each project. Round your answers to two decimal places.

Project A years

Project B years

b. Assuming the projects are independent, which one or ones would you recommend?

c. If the project are matually exclusive, which would yopu recommend?

d. Notice that the projects have the same cash flow timing pattern. Why is there a conflict between NPV and IRR?

Explanation / Answer

Answer:a NPV:

IRR:

Payback period:

Project A=3000/1000=3 years

Project B=9000/2800=3.214 years

discounted payback for each project:

Project A=4 years+25.7/542.7=4.047 years

PRoject B=4 years+671.96/1519.56=4.4420 years

Answer:b Assuming the project are independent, I would recommend 2 projects

Answer:c If the projects are mutually exclusive, I would recommend project B because NPV A <NPV B

Answer:d             Whether NPV or IRR gives better rankings depends on which has the better reinvestment rate assumption. Normally, the NPV's assumption is better. The reason is as follows: a project's cash inflows are generally used as substitutes for outside capital, that is, projects' cash flows replace outside capital and, hence, save the firm the cost of outside capital. Therefore, in an opportunity cost sense, a project's cash flows are reinvested at the cost of capital.

Project A Project B Year P.V.F (13%) Cash flow PV ($) Cash flow PV ($) 0 1 -3000 -3000 -9000 -9000 1 0.8849 1000 884.9 2800 2477.72 2 0.7831 1000 783.1 2800 2192.68 3 0.693 1000 693 2800 1940.4 4 0.6133 1000 613.3 2800 1717.24 5 0.5427 1000 542.7 2800 1519.56 NPV 517 847.6

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