Question 4

Swanson Industries has four potential projects all with an initial cost of $2,000,000. The capital

budget for the year will only allow Swanson industries to accept one of the four projects. Given

the discount rates and the future cash flows of each project, which project should they accept?

Cash Flows

Project M

Project N

Project O

Project P

Year one

$500,000

$600,000

$1,000,000

$300,000

Year two

$500,000

$600,000

$800,000

$500,000

Year three

$500,000

$600,000

$600,000

$700,000

Year four

$500,000

$600,000

$400,000

$900,000

Year five

$500,000

$600,000

$200,000

$1,100,000

Discount Rate

5%

9%

15%

22%

Answer:

Find the NPV of each project and compare the NPVs.

Project M's NPV = -$2,000,000 + $500,000/1.05 + $500,000/1.05

2

+ $500,000/1.05

3

+ $500,000/1.05

4

+ $500,000/1.05

5

Project M's NPV = -$2,000,000 + $476,190.48 + $453,514.74 + $431,918.80 +

$411,351.24 + $391,763.08

Project N's NPV = $164,738.34

Project N's NPV = -$2,000,000 + $600,000/1.09 + $600,000/1.09

2

+ $600,000/1.09

3

+ $600,000/1.09

4

+ $600,000/1.09

5

Project N's NPV = -$2,000,000 + $550,458.72 + $505,008.00 + $463,331.09 +

$425,055.13 + $389,958.83

Project N's NPV = $333,790.77

4

Project O's NPV = -$2,000,000 + $1,000,000/1.15 + $800,000/1.15

2

+ $600,000/1.15

3

+ $400,000/1.15

4

+ $200,000/1.15

5

Project O's NPV = -$2,000,000 + $869,565.22 + $604,914.93 + $394,509.74 +

$228,701.30 + $99,435.34

Project O's NPV = $197,126.53

Project P's NPV = -$2,000,000 + $300,000/1.22 + $500,000/1.22

2

+ $700,000/1.22

3

+

$900,000/1.22

4

+ $1,100,000/1.22

5

Project P's NPV = -$2,000,000 + $245,901.64 + $335,931.20 + $385,494.82 +

$406,259.18 + $406,999.18

Project P's NPV =-$219,413.98 (would reject project regardless of budget)

And the ranking order based on NPVs is,

Project N - NPV of $333,790.77

Project O - NPV of $197,126.53

Project M - NPV of $164,738.34

Project P - NPV of -$219,413.98

Swanson Industries should pick Project N.

Question 5

What are the IRRs of the four projects for Swanson Industries in problem 4?