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You have been asked to evaluate the following mutually-exclusive projects. The cost of capital for the firm is 12 percent. Assume all cash flows occur
You have been asked to evaluate the following mutually-exclusive projects. The cost of capital for the firm is 12 percent. Assume all cash flows occur at the end of each year.
- Project A has an initial investment of $20,000 with expected after-tax operating cash flows of $4,490 for each of the next 8 years and no expected salvage value.
- Project B has an initial investment of $20,000 with expected after-tax operating cash flows of $7,000 the first year, $8,000 the second year, $9,000 the third year, $10,000 the fourth year, and $11,000 the fifth year. In addition, a cash payment of $17,500 must be made at the end of Year 54 to pay for environmental costs incurred at the termination of the project.
- Project C has an initial investment of $20,000 with expected after-tax operating cash flows of $12,000 per year for each of the next 6 years. In addition, an additional investment of $38,000 must be made at the end of Year 3 to extend the life of the project to six years.
- Project D has an initial investment of $20,000 with expected after-tax operating cash flows of $125,000 per year for each of the next 3 years. However, in preparation for its termination at the end of year 3, an additional investment of $350,000 must be made at the end of Year 2 to cover environmental clean-up costs.
- Calculate the Net Present Value, Equivalent Annual Annuity, Internal Rate of Return, Modified Internal Rate of Return, Profitability Index, Payback Period, and Discounted Payback Period for each project.
- Given your results in part 1, describe under which set of circumstances or given which set of assumptions you would recommend choosing Project A. When might you instead recommend Project B, Project C, and Project D? Note that the figures have been constructed so each project will be preferred using at least one of the evaluation criteria.
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