9.) Sue has asked you to analyze the company’s glass division which has a cost o

Question

9.) Sue has asked you to analyze the company’s glass division which has a cost of capital equal to 10%. If the following projects are mutually exclusive, and you only have the information that is provided, which should you accept?

A

B

C

E

Payback (years)

1

5

2

5

IRR

18%

20%

20%

12%

NPV (Millions)

$40

$75

$35

$100

Justify your answer. What does the condition “mutually exclusive” mean? Why would the Division’s cost of capital be different than the company’s overall weighted cost of capital calculated in task 6?

Concept Check: Every organization is faced with multiple opportunities and limited resources. Management must develop systems to logically and impartially examine these options and allocate capital and other resources for the best outcome overall so the organization can expand within the limits of their mission.

Helpful Hint: Many financial models and rules are established to help managers determine best resource allocations. Just like any system, the variables or models can be manipulated to determine an outcome. There should be more than one way to analyze different opportunities and the variables used to measure efficiency need to be constantly monitored for relevancy and accuracy.

A

B

C

E

Payback (years)

1

5

2

5

IRR

18%

20%

20%

12%

NPV (Millions)

$40

$75

$35

$100

Explanation / Answer

Mutually exclusive projects are projects in which acceptance of one project excludes the others from consideration.The best projected is selected from the lot.

In case of mutually exclusive projects, the project with highest net present value or the highest IRR or the lowest payback period is preferred.

E has the highest NPV, B and C have better IRR, Payback is lowest in project A.

Since there is no clear winner here, We have to use relative percentages :

Since combined score of A is far better than, It is advised to make the decision in favour of Project A.

A B C E NPV/IRR 222% 375% 175% 833% NPV/PBP 4000% 1500% 1750% 2000% IRR/PBP 1800% 400% 1000% 240% Combined score 6200 2275 2925 3073

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