4/16/2010

Chapter 10. Chapter 10 P23 Build a Model

Gardial Fisheries is considering two mutually exclusive investments. The projects' expected net cash flows are as
follows:

Expected Net Cash Flows

Time Project A Project B
0 ($375) ($575)
1 ($300) $190
2 ($200) $190
3 ($100) $190
4 $600 $190
5 $600 $190
6 $926 $190
7 ($200) $0

a. If each project's cost of capital is 12%, which project should be selected? If the cost of capital is 18%, what
project is the proper choice?

@ 12% cost of capital @ 18% cost of capital

Use Excel's NPV function as explained in this
WACC = 12% WACC = 18% chapter's Tool Kit. Note that the range does not
include the costs, which are added separately.
NPV A = NPV A =

NPV B = NPV B =

At a cost of capital of 12%, Project A should be selected. However, if the cost of capital rises to 18%, then the choice is
reversed, and Project B should be accepted.

b. Construct NPV profiles for Projects A and B.

Before we can graph the NPV profiles for these projects, we must create a data table of project NPVs relative to
differing costs of capital.

Project A Project B
$0.00 $0.00
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
 20%
22%
24%
26%
28%
30%

c. What is each project's IRR?

We find the internal rate of return with Excel's IRR function:

IRR A = Note in the graph above that the X-axis intercepts are equal to the two projects' IRRs.
IRR B =

d. What is the crossover rate, and what is its significance?

Cash flow
Time differential
0
1
2 Crossover rate =
3
4 The crossover rate represents the cost of capital at which the two projects
5 have the same net present value. In this scenario, that common net present
6 value, at a cost of capital of 13.14% is:
7

e. What is each project's MIRR at a cost of capital of 12%? At r = 18%? (Hint: Consider Period 7 as the end of
Project B's life.)

@ 12% cost of capital @ 18% cost of capital

MIRR A = MIRR A =
MIRR B = MIRR B =

f. What is the regular payback period for these two projects?

Project A
Time period 0 1 2 3 4 5 6 7
Cash flow (375) (300) (200) (100) 600 $600 $926 ($200)
Cumulative cash flow
Payback

Project B
Time period 0 1 2 3 4 5 6 7
Cash flow (575) 190 190 190 190 $190 $190 $0
Cumulative cash flow
Payback

g. At a cost of capital of 12%, what is the discounted payback period for these two projects?
WACC = 12%

Project A
Time period 0 1 2 3 4 5 6 7
Cash flow (375) (300) (200) (100) 600 $600 $926 ($200)
Disc. cash flow
Disc. cum. cash flow
Discounted Payback

Project B
Time period 0 1 2 3 4 5 6 7
Cash flow (575) 190 190 190 190 $190 $190 $0
Disc. cash flow
Disc. cum. cash flow
Discounted Payback

h. What is the profitability index for each project if the cost of capital is 12%?

PV of future cash flows for A:

PI of A:

PV of future cash flows for B:

PI of B:
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