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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 ($350 ($500) ($300) $160 2 $200) 160 3 ($50) $160 $550 $160 $550 $16 6 $925 $16 $300) $0 If each project's cost of capital is WACC 1, which project should be selected? If the cost of capital is WACC 2, what project is the proper choice? Cost of capital 1 Cost of Capital 2 WACC = 12% WACC = 18% Use Excel's NPV function as explained in this chapter's Tool Kit. Note that the NPV A = NPV A range does not include the costs, which are added separately. NPV B NPV B At a cost of capital of 1, Project A should be selected. However, if the cost of capital rises to WACC 2, then the choice is reversed, and Project B should be accepted. 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 NPV NPV Profiles D% 2% 4% 6% Project A 8% 10% 12% 14% 16% Project B 18% 20% 22% 24% 26% 28% 30% Cost of CapitalWhat is each project's IRR? 0% 5% 10% 19% 20% 30% We find the internal rate of return with Excel's IRR function: IRR A IRR B = Note in the graph above that the X-axis intercepts are equal to the two projects' IRRs. What is the crossover rate, and what is its significance? Cash flow Time differential 0 DU A W N Crossover rate = The crossover rate represents the cost of capital at which the two projects have the same net present value. In this scenario, that common net present What is each project's MIRR at each cost of capital? Hint: note that B is a 6-vear project Cost of Capital 1 Cost of Capital 2 WACC 1= 12% WACC 2 = 18% MIRR A MIRR A MIRR B MIRR B What is the regular payback period for these two projects? Project A Time period 3 5 7 Cash flow (350) (300) (200) (50) 550 $550 $925 ($300) Cumulative cash flow Intermediate calculation for payback Payback using intermediate calculations Project B Time period 0 2 3 4 5 Cash flow 6 Cumulative cash flow $500 $160 $160 $160 $160 $160 $160 1 SO Intermediate calculation for payback Payback using intermediate calculations Payback using PERCENTRANK Ok because cash flows follow normal pattern. At a the given cost of capital, what is the discounted payback period for these two projects? WACC = 12% Project A Time period Cash flow 0 $350 1 -$300 2 $20 $50 4 $550 6 1 Disc. cash flow $925 $300 Disc. cum. cash flow Intermediate calculation for paybackg. At a the given cost of capital, what is the discounted payback period for these two projects? WACC = 12% Project A Time period 0 1 Cash flow 2 $350 3 $300 $200 5 $50 6 7 Disc. cash flow $550 $550 $925 -$300 Disc. cum. cash flow Intermediate calculation for payback Payback using intermediate calculations Project B 1 2 3 4 5 6 7 Disc. cum. cash flow Intermediate calculation for payoct Payback using intermediate calculations Discounted Payback using PERCENTRANK Ok because cash flows follow normal pattern. 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
