Contents

Part 1..........................................................................................................................................................2
Answer 1..................................................................................................................................................2
Answer 2..................................................................................................................................................2
Net present value (NPV):....................................................................................................................2
Internal rate of return (IRR):...............................................................................................................3
Payback Period (PP):...........................................................................................................................4
Profitability index (PP)........................................................................................................................5
Answer 3..................................................................................................................................................5
Answer 4..................................................................................................................................................6
Part 2..........................................................................................................................................................7
Answer 1..................................................................................................................................................7
Answer 2..................................................................................................................................................7
Calculation of Net present value (NPV):.............................................................................................7
Calculation of Internal rate of return (IRR):.......................................................................................9
Calculation of Payback Period (PP):....................................................................................................9
Calculation of Modified Internal rate of return (MIRR):....................................................................9

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 Part 1
Answer 1
By inspecting the cashflows without using any methods, the rank could be come by looking at
excess of cashflow over investment,

Rank Project No Net cash flow

1 3 $7,000,000
2 2 $5,165,000
3 6 $4,200,000
4 7 $2,500,000
5 5 $2,200,000
6 8 $2,150,000
7 4 $1,562,000
8 1 $1,310,000

From the above table it is clear that, the project could be ranked by using the net cash flows
easily. However, it is important to use the net cashflows of the future outcomes. Therefore, it is
important to use present value of the future cashflows in order to get better results for the
decision-making process.

Answer 2
There are many methods that the organization can use in order to rank the project. It mainly
depends on the users of different methods. Some of the popular methods are as follows,

A. Net present value (NPV)

B. Internal rate or return (IRR)
C. Payback period (PP)
D. Profitability index (PI)

Net present value (NPV):

NPV (Net Present Value) is the present value of an investment’s future net cash flow minus the
initial investment. For an investment we need a positive NPV. If NPV is positive then the
investment should be made either if it is negative then the investment should not be made. For an
investment we need a positive NPV.

Decision Rules for NPV

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 1. NPV > 0 : Accept Project
2. NPV < 0 : Reject Project
3. NPV = 0 IRR/Brocken down

NPV for 8 Projects:

Projects Project 1 Project Project Project Project Project Project 7 Project 8

2 3 4 5 6
NPV
outcom $ $ $ $ $ $ $
e $ 73.08 1842.5 154.53 228.22 129.70 2076.00 942.23 182.98
Rank 8 2 6 4 7 1 3 5

Internal rate of return (IRR):

IRR (Internal Rate of Return) is a financial metric used to price and compare investments,
business case scenarios, or other kinds of projected cash flow results.

Here I am putting the formula for IRR analysis:

1 NPV 1
IRR = R+ ∗( R2−R 1)
NPV 1−NPV 2
R1 = Rate used to obtain the positive NPV
R2 = Rate used to obtain the negative NPV
NPV1 = Positive NPV
NPV2 = Negative NPV

IRR for 8 projects:

Projects Project Project Project Project Project Project Project 7 Project 8

1 2 3 4 5 6
IRR 10.87% 28.16% 10.55% 12.33% 11.12% 43.21% 25.43% 11.41%
Rank 6 2 7 4 8 1 3 5

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Payback Period (PP):
Payback period is one of the techniques for investment. It shows the capital payback time. By
calculating payback period, a businessman can easily know the period that when he will get his
money back. It is also indicating the period that from when the owner of the business will start
earning profit. Normally it is the default technique for the small business. It focuses only cash
flow. It does not show the profit.

Payback period for the 8 projects,

Projects Project 1 Projec Project Project Project Project Project 7 Project 8

t2 3 4 5 6
Payback 7 2 15 6 8 1 2 7
Year
Rank 5 2 8 4 7 1 2 5

Advantages of payback period:

 Payback method is very simple to calculate

 It only uses project cash flows. It don’t face make any difficulties.
 Payback method always favors projects which may get profit very quickly.
 It helps to find the project which may very profitable and investors can get back money
quickly.

Disadvantages of Payback period:

 Payback does not show overall worth of the project.

 It never shows the time value of money.
 It does not show the future difficulties that can be effect the business.

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Profitability index (PP)
The profitability index (PI), alternatively referred to as value investment ratio (VIR), or profit
investment ratio (PIR), describes an index that represents the relationship between the costs and
benefits of a proposed project, using the following ratio:

Projects Project Project Project Project Project Project Project 7 Project

1 2 3 4 5 6 8
Profitabilit 1.65 3.58 4.5 1.78 2.1 3.1 2.28 2.07
y index
Rank 8 2 1 7 5 3 4 6

All the projects are undertaken except project 8. It is because it is mutually exclusive with
project 7 and project 7’s performance is better than project 8 in all the calculations.

On the other hand, by looking at all the methods it could be said that, NPV outcomes provides
more importance than other outcomes. It is because, NPV considers discounted cashflows of the
future investment which reduces risks of the project and it is much helpful for the decision-
making process.

On the other hand, project 6, 7 and 3 has been to top four all the time in all the calculations.
Therefore, it could be said that, all those three projects are viable according to quantitative
methods. However, as only one project needs to be considered, therefore, by looking at NPV
outcomes, the project could be considered. As project 6 has got maximum outcomes according to
NPV table, therefore, the company can choose project 6 among all 8 projects.

Answer 3
Following is the ranking that has been found from quantitative methods,

Rank 1st 2nd 3rd 4th

Projects Project 6 Project 2 Project 7 Project 4

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The ranking is different from simple inspections of the cashflows. It is because, the ranking has
taken place after deducting the costs of capital from the cashflows.

Answer 4
Following are the estimated real investment projects that could be similar to the cash flows,

1 Project 1 Bonds
2 Project 2 Equipment depreciation
3 Project 3 Land or real estate investment
4 Project 4 Dairy factory that incur agricultural costs
5 Project 5 Car loan
6 Project 6 Stock
7 Project 7 Trucks depreciation
8 Project 8 Construction Project

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 Part 2
Answer 1
Total firm value= $2,000,000 + $500,000 + 2,500,000

= $5,000,000

Therefore,

Formula for WACC is as follows,

WACC= cost of equity * % Equity + Cost of Debt * %Debt * (1-Tax rate) + Cost of Preferred
stock * % Preferred stock

2000000 500000 2500000

WACC= {
5000000
∗¿.36)*0.1} + (
5000000
∗0.14 +(
5000000 )
∗0.16)

= 0.0256 + 0.014 + 0.08

=0.1196

= 11.96%

Answer 2
Calculation of Net present value (NPV):
  Project1 Project2 Project3 Project4 Project5 Project6 Project7 Project8
$ $ $ $
Initial 2,000.0 2,000.0 2,000.0 $ $ 2,000.0 $ 2,000.0
Investment 0 0 0 2,000.00 2,000.00 0 2,000.00 0
Year                
$ $ $ $ $ $ $
1 300.00 1514.55   145.45 254.55 1818.00 1090.91 (318.18)
$ $ $ $ $ $
2 272.73 276.03   165.29 231.40   743.80 (49.59)
$ $ $ $ $ $
3 247.93 123.97   262.96 210.37   225.39 45.08
$ $ $ $ $
4 225.39     269.79 191.24   61.47 239.05
5 $     $ $   $ $

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 204.90 268.84 173.86 43.46 434.64
$ $ $ $ $
6 186.28     248.37 158.05 2258.00   677.37
$ $ $ $
7 169.34     226.82 143.68     1154.61
$ $ $
8 466.51     207.13 130.62      
$ $ $
9       189.15 118.75   848.20  
$ $ $
10   1927.50   172.72 107.95      
$ $
11       157.72 98.14      
$ $
12       143.70 89.22      
$ $
13       130.64 81.11      
$ $
14       119.03 73.73      
$ $ $
15     2393.92 (478.8) 67.03      
$ $ $ $ $ $ $ $
Total DCF 2073.08 3842.5 2154.53 228.22 129.70 4076.00 2942.23 2182.98
Excess of
cashflow
Over $ $ $ $ $ $ $ $
investment 73.08 1842.5 154.53 228.22 129.70 2076.00 942.23 182.98
Rank 8 2 6 4 7 1 3 5

Calculation of Internal rate of return (IRR):

Project Project Project Project Project Project Project Project Project

s 1 2 3 4 5 6 7 8
IRR 10.87% 28.16% 10.55% 12.33% 11.12% 43.21% 25.43% 11.41%
Rank 6 2 7 4 8 1 3 5

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According to IRR rules, the project could be acceptable if the outcomes of outcomes are more
than costs of capital. The case has shown that, cost of capital is 10%. Therefore, all the projects
are viable according to IRR rules.

Calculation of Payback Period (PP):

Project Project 1 Project Project Project Project Project Project Project

s 2 3 4 5 6 7 8
Payback 7 2 15 6 8 1 2 7
Year
Rank 5 2 8 4 7 1 2 5

Calculation of Modified Internal rate of return (MIRR):

Project Project Project Project Project Project Project Project Project

s 1 2 3 4 5 6 7 8
IRR 10.49% 17.42% 10.55% 10.65% 10.46% 24.76% 15.13% 11.18%
Rank 7 2 6 5 8 1 3 4

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