Question
VMG Company is considering investing in Project R, which will require an outlay of $800 million. The project will have a five-year life and at
VMG Company is considering investing in Project R, which will require an outlay of $800 million. The project will have a five-year life and at the end of that time, the equipment will be scrapped. The following information about two mutually exclusive projects R and T is relevant for requirements 1(a) to 1(c) only.
The Project R is expected to generate the following annual cash flows:
Year-1 | Year-2 | Year-3 | Year-4 | Year-5 | |
Cash inflows | $610m | $520m | $510m | $310m | $160 |
Cash outflows | $210m | $190m | $190m | $160m | $90 |
The company has a required rate of return of 14.20%. The company normally has three-year discounted payback criteria.
The alternative Project-T offers the following net cash flows:
Year-0 ($800m); Year-1 $200m; Year-2 $257m; Year-3 $323m; Year-4 $366m; and Year-5 $366m.
(a) Calculate the (i) NPV, (ii) IRR, (iii) PVI, (iv) Payback period, (v) Discounted payback period for projects R and T.
(b) Calculate the crossover rate (between projects R and T) based on the above cash flow data. Show the range of required rates for which either Project-R or Project-T would be preferred.
(c) Based on your findings in requirements a and b above, what would be the decision of selection of project (when the required rate of return is 14.20 percent)?
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