John Andrews, the CFO of Fitch Services is trying to select the best investment

Question

John Andrews, the CFO of Fitch Services is trying to select the best investment from among four proposals submitted by his divisional managers. Each proposal involves an initial outlay of $120,000. Their cash flows follow: Year Emily Frank Gina Henrique 1 $ 24,000 $72,000 $36,000 $    -   2    30,000 42,000 36,000      -   3    30,000 36,000    36,000 54,000 4     54,000           -   36,000 78,000 5     66,000          -   36,000 119,000 Evaluate and rank each alternative based on a) payback period, b) net present value (use a 15% discount rate), and c) internal rate of return. Be sure to show your work in an excel file! Cost $120,000 Discount Rate 15% a) What is the Payback Period for for each alternative? Emily Frank Gina Henrique      Which alternative would you choose using the payback period? b) What is the Net Present Value for each project using a 15% discount rate? Emily Frank Gina Henrique      Which alternative would you choose using the NPV using a 15% discount rate? c) What is the IRR for each Project? Emily Frank Gina Henrique      Which alternative would you choose using the IRR? John Andrews, the CFO of Fitch Services is trying to select the best investment from among four proposals submitted by his divisional managers. Each proposal involves an initial outlay of $120,000. Their cash flows follow: Year Emily Frank Gina Henrique 1 $ 24,000 $72,000 $36,000 $    -   2    30,000 42,000 36,000      -   3    30,000 36,000    36,000 54,000 4     54,000           -   36,000 78,000 5     66,000          -   36,000 119,000 Evaluate and rank each alternative based on a) payback period, b) net present value (use a 15% discount rate), and c) internal rate of return. Be sure to show your work in an excel file! Cost $120,000 Discount Rate 15% a) What is the Payback Period for for each alternative? Emily Frank Gina Henrique      Which alternative would you choose using the payback period? b) What is the Net Present Value for each project using a 15% discount rate? Emily Frank Gina Henrique      Which alternative would you choose using the NPV using a 15% discount rate? c) What is the IRR for each Project? Emily Frank Gina Henrique      Which alternative would you choose using the IRR?

Explanation / Answer

PART a

Payback period = cost of investment / sum of total cash inflows

Since the payback period for Henrique is less than other alternatives, henrique should be choosen.

PART b NPV

NPV = discounted cash inflow - cash outflow

Henrique should be choosed as NPV is greater than other alternatives.

PART C IRR

IRR = ra +[ NPVa / (NPVa - NPVb) ] ( rb -ra )

ra = lower discount rate choosen

rb = higher discount rate choosen

NPVa = NPV at ra

NPVb = NPV at rb

EMILY

IRR = 15 + [ 6970.8/ ( 6970.8 - (-3154.2)] (18-15)

= 17.06%

FRANK

IRR = 13 + [1566/(1566-(-1962.6)] (15-13)

= 13.89%

GINA

-2121.600

IRR = 15 + [679.2/(679.2-(-2121.6)] (16-15)

= 15.24%

Henrique

-3299.30

IRR = 15 + [19272.2/(19272.2-(-3299.3)] (20-15)

=19.27%

Henrique will be choosen as its IRR is highest compared to other alternatives.

Emily Frank Gina Henrique Cash inflows($) Cash inflows($) Cash inflows($) Cash inflows($) 24000 72000 36000 0 30000 42000 36000 0 30000 36000 36000 54000 54000 0 36000 78000 66000 0 36000 119000 Total cash inflows 204000 150000 180000 251000 Cash outflow / initial investment 120000 120000 120000 120000 Payback period 0.59 0.80 0.67 0.48

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