After graduating from an MBA Program on the East Coast, Michael Strahan had started working for a mining company. His company is evaluating two projects: One of them requires a smaller investment, and then will create a big, positive cash flow in the first year; and then smaller cash flows after that. The second project is a relatively bigger project. It will require a larger cash flow at the beginning, and then will bring in a relatively small cash flow in the first year. But, this second project will create much larger cash flows in the years after that. Michael has been given the task of evaluating these two projects and choosing the best one for his company. Initially he thought that this would be an easy task for him. He would just try to accurately predict the cash flows from the two projects and then evaluate them using some of the capital budgeting techniques that he had learned when he was at school.

The Decision Michael has requested some help in estimating the two projects' cash flows from his colleagues. The expected cash flows for the two projects are finalized as follows: Expected CFs associated with the two projects: T 0 1 2 3 Project 1 - $20 million + $12 million + $8 million + $5 million Project 2 - $30 million + $5 million + $15 million + $20 million He knowsfihat for similar projects, his company has used a required return of 12%, so he decides to use that required rate of return in his calculations. To impress his boss, he wants to do a detailed analysis. He wants to answer all of the following questions: 1. He decides to use the IRR method first. He wants to see which project is better according to the IRRs. After some calculations, he finds that one project looks better than the other when IRRs are compared. Which project is he talking about? 2. Is IRR an acceptable method to compare two mutually exclusive projects? 3. Is NPV an acceptable method when comparing two mutually exclusive projects? 4. Later, he visits one of his colleagues and talks about his findings. His colleague recommends him to check the NPVs also. He says O.K. Why not? Confirming my findings with the other method would be nice". What does he find? Do NPVs confirm his earlier findings? 5. Are both methods (i.e. NPV and IRR) good in these situations? What would you do? According to your opinion, which project is better for this company? 6. Does IRR always choose the same project whether a firm has a high cost of capital or a low cost of capital? 7. How about NPV? Does NPV always choose the same project whether a firm has a high cost of capital or a low cost of capital? 8. Michael finds his results confusing so he decides to prepare the NPV Profiles for the two projects. His colleague has just shown him how to prepare an NPV profile. How will the NPV profiles look like? 9. Accordin, to the NPV Profiles of the two projects, at what discount rate are these two projects equivalent? 10. Over what range of discount rates should we choose Project A? Project B? 11. If they were independent projects rather than mutually exclusive projects, what would we do? References The Decision Michael has requested some help in estimating the two projects' cash flows from his colleagues. The expected cash flows for the two projects are finalized as follows: Expected CFs associated with the two projects: T 0 1 2 3 Project 1 - $20 million + $12 million + $8 million + $5 million Project 2 - $30 million + $5 million + $15 million + $20 million He knowsfihat for similar projects, his company has used a required return of 12%, so he decides to use that required rate of return in his calculations. To impress his boss, he wants to do a detailed analysis. He wants to answer all of the following questions: 1. He decides to use the IRR method first. He wants to see which project is better according to the IRRs. After some calculations, he finds that one project looks better than the other when IRRs are compared. Which project is he talking about? 2. Is IRR an acceptable method to compare two mutually exclusive projects? 3. Is NPV an acceptable method when comparing two mutually exclusive projects? 4. Later, he visits one of his colleagues and talks about his findings. His colleague recommends him to check the NPVs also. He says O.K. Why not? Confirming my findings with the other method would be nice". What does he find? Do NPVs confirm his earlier findings? 5. Are both methods (i.e. NPV and IRR) good in these situations? What would you do? According to your opinion, which project is better for this company? 6. Does IRR always choose the same project whether a firm has a high cost of capital or a low cost of capital? 7. How about NPV? Does NPV always choose the same project whether a firm has a high cost of capital or a low cost of capital? 8. Michael finds his results confusing so he decides to prepare the NPV Profiles for the two projects. His colleague has just shown him how to prepare an NPV profile. How will the NPV profiles look like? 9. Accordin, to the NPV Profiles of the two projects, at what discount rate are these two projects equivalent? 10. Over what range of discount rates should we choose Project A? Project B? 11. If they were independent projects rather than mutually exclusive projects, what would we do? References