This homework submission should include all calculations for part (a), completed

Question

This homework submission should include all calculations for part (a), completed on the designated tab of the Homework Student Workbook, and a document explaining the implications of your findings for the business or business transaction. After reading the assigned chapters, respond to the following:

You are a financial analyst for the Brittle Company. The director of capital budgeting has asked you to analyze two proposed capital investments: Projects X and Y. Each project has a cost of $10,000, and the cost of capital for each is 12%. The projects' expected net cash flows are shown in the table below.

Expected Net Cash Flows

Year

Project X

Project Y

0

– $10,000

– $10,000

1

6,500

3,500

2

3,000

3,500

3

3,000

3,500

4

1,000

3,500

Use the Homework Student Workbook to calculate each project's net present value (NPV), internal rate of return (IRR), modified internal rate of return (MIRR), and profitability index (PI).

Which project or projects should be accepted if they are independent?

Which project or projects should be accepted if they are mutually exclusive?

Year

Project X

Project Y

0

– $10,000

– $10,000

1

6,500

3,500

2

3,000

3,500

3

3,000

3,500

4

1,000

3,500

Explanation / Answer

project's net present value (NPV), internal rate of return (IRR), modified internal rate of return (MIRR), and profitability index (PI) calculation:

NPV of Project X = $966.01

NPV of Project Y = $630.72

The internal rate of return (IRR) of project X is 18.03% and for Project Y it is 14.96% [you can use excel also to calculate IRR “=IRR (cash flow values)”]

OR

You can use following formula to calculate internal rate of return (IRR)

Sum of [cash flows/ (1+IRR) ^t] - initial cash outflow = 0

The MIRR for Project X where cost of capital r = 12%

PV of cost = $10,000

Terminal value or future value of cash inflows = $6500*(1.12) ^4 + $3000*(1.12) ^3 + $3000*(1.12) ^2 +$1000*(1.12) ^1

= $10,227.88 + $4,214.78 + $3,763.20 +$1,120.00

= $19,325.86

The MIRR is that discount rate which forces the Terminal value or future value of cash inflows of $19,325.86 in 4 years to equal $10,000

$10,000 = $19,325.86 / (1+MIRR) ^4

MIRR of Project X = 17.91%.

Similarly, MIRR of Project Y = 13.73%

Profitability Index (PI) of project can be find by divide its present value of future cash flows by its initial cost

For project X, PI = ($5,804 + $2,392 + $2,135 +$636)/ $10,000 = 1.10

For project Y, PI = ($3,125 + $2,790 + $2,491 + $2,224)/ $10,000 = 1.06

On each parameter Project X is better than project Y; therefore Project X should be accepted.

Year (t) Project X PV of X@ 12% [Cash Flow/(1+12%)^t] Project Y PV of Y@ 12% [Cash Flow/(1+12%)^t] 0 ($10,000) ($10,000) ($10,000) ($10,000) 1 $6,500 $5,804 $3,500 $3,125 2 $3,000 $2,392 $3,500 $2,790 3 $3,000 $2,135 $3,500 $2,491 4 $1,000 $636 $3,500 $2,224 NPV (Sum of PVs) $966.01 $630.72 IRR 18.03% 14.96% MIRR 17.91% 13.73% PI 1.10 1.06

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