questions 1-3
Jamie Dermott: Mutually Exclusive Project Analysis Jamie Dermott graduated from Midland State University in June and has been working for about a month as a junior financial analyst at Caledonia Products. When Jamie arrived at work on Friday morning, he found the following memo in his e-mail: TO: Jamie Dermott FROM: V. Morrison, CFO, Caledonia Products RE: Capital-Budgeting Analysis Provide an evaluation of two proposed projects with the following cash flow forecasts: Year Project A Project B 0 (initial outlay) S(110,000) $(110,000) 20,000 40,000 30,000 40,000 40,000 40,000 w 50,000 40,000 70,000 40,000 Because these projects involve additions to Caledonia's highly successful Avalon product line, the company requires a rate of return on both projects equal to 12 percent. As you are no doubt aware, Caledonia relies on a number of criteria when evaluating new investment opportunities. In particular, we require that projects that are accepted have a payback period of no more than three years, provide a positive NPV, and have an IRR that exceeds the firm's discount rate. Give me your thoughts on these two projects by 9 AM. Monday morning Jamie was not surprised by the memo, for he had been expecting something like this for some time. Caledonia followed a practice of testing each new financial analyst with some type of project evaluation exercise after the new hire had been on the job for a few months. After rereading the memo, Jamie decided on his plan of attack. Specifically, he would first do the obligatory calculations of payback period, NPV, and IRR for both projects. Jamie knew that the CFO would grill him thoroughly on Monday morning about his analysis, so he wanted to prepare well for the experience. One of the things that occurred to Jamie was that the memo did not indicate whether the two projects were independent or mutually exclusive. So, just to be safe, he thought he had better rank the two projects in case he was asked to do so on Monday morning. Jamie sat down and made up the following "to do" list: 1. Compute payback period, NPV, and IRR for both projects. 2. Evaluate the two projects' acceptability using all three decision criteria (listed above) and basing the conclusion on the assumption that the projects are independent-that is, that both could be accepted it both are acceptable. 3. Rank the two projects and make a recommendation as to which (If either) should be accepted under the assumption that the projects are mutually exclusive
