Your division is considering two investment projects, each of which requires an

Question

Your division is considering two investment projects, each of which requires an up-front expenditure of $25 million. You estimate that the cost of capital is 10% and that the investments will produce the following after-tax cash flows (in millions of dollars):

Year

Project A

Project B

1

$5 mil.

$20 mil.

2

$10 mil.

$10 mil.

3

$15 mil.

$8 mil.

4

$20 mil.

$6 mil.

a. What is the regular payback period for each of the projects?

b. What is the discounted payback period for each of the projects?

c. If the two projects are independent and the cost of capital is 10%, which project or projects should the firm undertake?

d. If the two projects are mutually exclusive and the cost of capital is 5%, which project should the firm undertake?

e. If the two projects are mutually exclusive and the cost of capital is 15%, which project should the firm undertake?

What is the crossover rate?

gf. . If the cost of capital is 10%, what is the modified IRR (MIRR) of each project?

Year

Project A

Project B

1

$5 mil.

$20 mil.

2

$10 mil.

$10 mil.

3

$15 mil.

$8 mil.

4

$20 mil.

$6 mil.

Explanation / Answer

a)Payback Period

Project A = 2.66 years

Project B = 1.5 years

b) Discounted Payback period

Discounted Payback period = 3.067

Discounted Payback period = 1.825 years

c) The NPV of both projects are positive hence they both should be accepeted

NPV is = -25 +5/1.1 +10/1.1^2 + 15/1.1^3 + 20/1.1^4

=11.58

And NPV of project B would be 10.50

d) As project are mutualy exclusive

NPV is project 17.38

NPV pf project is 14.25

Hence project a should be accepted

Doscounted Payback Period 0 -25 1 5 4.545455 2 10 8.264463 3 15 11.26972 4 20 13.66027

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