Rouse Corp is considering 2 mutually exclusive capital projects with the followi

Question

Rouse Corp is considering 2 mutually exclusive capital projects with the following cash flow: year 0 project a (165,000) Project B (165,000) Year 1 A = $25,000 B= $90,000 //Year 2 A = $25,000 B = $80,000 Year 3 A = $50,000 B = $60,000 Year 4 A = $50,000 B = 40,000. Year 5 A = $225,000 B = $30,000. Each project has a useful life of 5 years. Each project has a zero salvage value at the end of the 5 year period. Depreciation willbe calculated using the straight line depreciation method. Rouse uses WACC as its minimum desired rate of return. The WACC for Rouse is currently at 12.5 %. Compute the following items for each project. a. payback period. b. IRR c. MIRR d. NPV e. explain which project you would recommend be selected along with the reasons why you selected one project over the other one.

Explanation / Answer

Answer a Calculation of pay back period Project A Project B Year Cash flows Cumulative Cash flow Year Cash flows Cumulative Cash flow 0 -$165,000.00 -$165,000.00 0 -$165,000.00 -$165,000.00 1 $25,000.00 -$140,000.00 1 $90,000.00 -$75,000.00 2 $25,000.00 -$115,000.00 2 $80,000.00 $5,000.00 3 $50,000.00 -$65,000.00 3 $60,000.00 $65,000.00 4 $50,000.00 -$15,000.00 4 $40,000.00 $105,000.00 5 $225,000.00 $210,000.00 5 $30,000.00 $135,000.00 Payback period of Project A = 4 years + ($15000/$225000) = 4.07 years Payback period of Project B = 1 year + ($75000/$80000) = 1.94 Years Answer b Calculation of IRR Project A Project B Year Cash flows Year Cash flows 0 -$165,000.00 0 -$165,000.00 1 $25,000.00 1 $90,000.00 2 $25,000.00 2 $80,000.00 3 $50,000.00 3 $60,000.00 4 $50,000.00 4 $40,000.00 5 $225,000.00 5 $30,000.00 IRR of project A 23.10% IRR of Project B 30.37% Answer c MIRR i.e. modified Internal rate of return = [FVCF / PVCF]^(1/n) - 1 FVCF = Future value of positive cash flows at the cost of capital PVCF = present value of negative cash flows n = no.of years Calculation of future value of positive cash flows Project A Project A Year FV factor @ 12.5% Cash flows Future Values Year FV factor @ 12.5% Cash flows Future Values 1         1.601807 $25,000.00 $40,045.17 1            1.601807 $90,000.00 $144,162.60 2         1.423828 $25,000.00 $35,595.70 2            1.423828 $80,000.00 $113,906.25 3         1.265625 $50,000.00 $63,281.25 3            1.265625 $60,000.00 $75,937.50 4         1.125000 $50,000.00 $56,250.00 4            1.125000 $40,000.00 $45,000.00 5         1.000000 $225,000.00 $225,000.00 5            1.000000 $30,000.00 $30,000.00 Future value of positive cash flows $420,172.12 Future value of positive cash flows $409,006.35 MIRR of Project A = [$420172.12 / $165000]^(1/5) - 1 MIRR of Project B = [$409006.35 / $165000]^(1/5) - 1 MIRR of Project A = 2.55^(1/5) - 1 MIRR of Project B = 2.48^(1/5) - 1 MIRR of Project A = 1.2056 - 1 = 20.56% MIRR of Project B = 1.1991 - 1 = 19.91% Answer d Calculation NPV Calculation of future value of positive cash flows Project A Project A Year Discount factor @ 12.5% Cash flows Future Values Year Discount factor @ 12.5% Cash flows Future Values 0            1.00000 -$165,000.00 -$165,000.00 0              1.00000 -$165,000.00 -$165,000.00 1            0.88889 $25,000.00 $22,222.22 1              0.88889 $90,000.00 $80,000.00 2            0.79012 $25,000.00 $19,753.09 2              0.79012 $80,000.00 $63,209.88 3            0.70233 $50,000.00 $35,116.60 3              0.70233 $60,000.00 $42,139.92 4            0.62430 $50,000.00 $31,214.75 4              0.62430 $40,000.00 $24,971.80 5            0.55493 $225,000.00 $124,859.02 5              0.55493 $30,000.00 $16,647.87 NPV $68,165.68 NPV $61,969.47 Recommendation Project A should be selected as it has higher MIRR and NPV compared to Project B/

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