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Last Tuesday, Green Caterpillar Garden Supplies Inc. lost a portion of its planning and financial data when both its main and its backup servers crashed.
Last Tuesday, Green Caterpillar Garden Supplies Inc. lost a portion of its planning and financial data when both its main and its backup servers crashed. The company's CFO remembers that the internal rate of return (IRR) of Project Delta is 13.8%, but he can't recall how much Green Caterpillar originally invested in the project nor the project's net present value (NPV). However, he found a note that detailed the annual net cash flows expected to be generated by Project Delta. They are: Year Cash Flow er1 $1,800,o0o Year 2 $3,375,000 Year 3 3,375,000 Year 4 $3,375,000 The CFO has asked you to compute Project Delta's initial investment using the information currently available to you He has offered the fol lowing suggestions and observations . A project's IRR represents the return the project would generate when its NPV is zero or the discounted value of its cash inflows equals the discounted value of its cash outlows-when the cash flows are discounted using the project's IRR. The level of risk exhibited by Project Delta is the same as thet exhibited by the company's Answer Choices average prnject, which means that Project Delta's net cash flows can be discounted using Green Caterpillar's 8% WACC. 1 Given the data and hints, Project Delta's initial investment is (rcunded to the nearest whole dellar) A project's IRR will An NPV profile plots a project's NPV at various costs of capital. A project's NPV profile is shown as follows. Identify the range of costs of capital that a firm would use to acccpt and rejcct this project. , and its NPV is2 1. $8,849,868, $8,605,839, $9,874,235, $8,490,228 2. $1,229,867, $1,168,374, $1,106,880, $1,414,347 3. Increase, Stay the Same, Decreas 4. Reject, Accept 5. Reject, Accept 6. A, B 7. Sometimes, Always, Never if the project's cash inflows increase, and everything else is unaffected. NPV IDollars) 400 4 9. Modified Internal Rate of Return (MIRR), Internal Rate of Return (IRR), Required Rate of return 10. Modified Internal Rate of Return (MIRR), Internal Rate of Return (IRR), Required Rate of return 11. NPV Method, IRR Method 100 0 2 68 10 12 14 16 18 20 COST OF CAPITAL [Percent) True or False: The NPV and IRR methods can lead to conflicting decisions for mutually exclusive projects. False BO True Ir prajects are mutually exlusive, only one project can be chosen. The internal rate of return (IRR) and the net present value (NPv) methods will not always choose the same project. If the crossover rate on the NPV profile is below the horizontal axis, the methods will Projects W and X are mutually exclusive projects. Their cash flows and NPV profiles are shown as follows. agree. NPV [Dollars Year Project W Project X 800 1,000 -$1,500 $350 $500 $200 $350 600 Project X $600 $600 $750 400 Project W If the weighted average cost of capital (WACC) for each project is 14%, do the NPV and IRR methods agree or conflict? A O The methods conflict. BO The methods agree. 200 0 2 468 10 12 4 16 18 20 A key to resolving this conflict is the assumed reinvestment rate The NPV calculation implicitly assumes tha intermediate COST OF CAPITAL IPercent cash fiows are reinvested at the assumes that the rate at which cash flows can be reinvested is the As a result, when evaluating mutually exclusive projects, the 11 and the IRR calculation 10 is usually the better decision criterian
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