Decision Criteria of NPV

If NPV > 0, accept the project

If NPV < 0, reject the project

The decision rule for mutually exclusive project is to select the project with the highest NPV.

Internal Rate of Return (IRR) is the intrinsic rate of return the project is likely to generate. The IRR is the discount rate or the rate of return that will equate the present value of the cash outflows with the present value of the cash inflows (i.e. NPV = 0).

Decision Rule:

Accept the project if IRR > cost of capital

Reject the project if IRR < cost of capital

Exhibit 1: The expected cash flows in US$ from the project in Ohio and North Dakota.

Year	Cash flow (Ohio)	Cash flow (ND)
0	(2,000,000)	(2,200,000)
1	180,000.00	150,000.00
2	240,000.00	180,000.00
3	280,000.00	200,000.00
4	300,000.00	290,000.00
5	520,000.00	380,000.00
6	480,000.00	590,000.00
7	530,000.00	410,000.00
8	585,000.00	583,000.00
9	590,000.00	580,000.00
10	592,000.00	620,000.00

The companys policy is to select projects using NPV technique.

1a Gregg wants to analyze the risk of the project using sensitivity analysis and Monte Carlo simulation.

a. Explain to Baldwin Inc. how the two risk analysis models can be used to analyze risk of the project.

2a Gregg has estimated the fixed costs (including depreciation) of the Ohio project to be $1.5 million, sales price is $130, and the variable cost is $70, giving a contribution margin of $60. What is the break-even quantity for this project?

3a Baldwin Inc. wants to know the likely effect of the capital budgeting decision on its stock price (increase, decrease, no change, or not sure). Choose one and explain why.

Cost of Capital is 12% for Ohio and 10% for North Dakota