Sufian Doleh CSU ID 2356325

FIN 501

7/19/2013 0:00

Chapter 10. Solution for Chapter 10 P23 Build a Model

Gardial Fisheries is considering two mutually exclusive investments. The projects' expected net cash flows are as follows: Expected Net Cash Flows Project A Project B ($375) ($575) ($300) $190 ($200) $190 ($100) $190 $600 $190 $600 $190 $926 $190 ($200) $0

Time 0 1 2 3 4 5 6 7

a. If each project's cost of capital is 12%, which project should be selected? If the cost of capital is 18%, what project is the proper choice? @ 12% cost of capital WACC = NPV A = NPV B = 12% $226.96 $206.17 @ 18% cost of capital WACC = NPV A = NPV B = Use Excel's NPV function as explained in this 18% chapter's Tool Kit. Note that the range does not include the costs, which are added separately. $18.24 $89.54

At cost of capital of 12 percent, Project A should be selected. But if the cost of capital rises to 18 percent, then Project B should be accepted instead.
b. 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 $226.96 $951.00 $790.31 $648.61 $523.41 $412.58 $314.28 $226.96 $149.27 $80.03 $18.24 ($36.98) Project B $206.17 $565.00 $489.27 $421.01 $359.29 $303.35 $252.50 $206.17 $163.85 $125.10 $89.54 $56.85 NPV
$1,000

NPV Profiles

0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20%

$800

Project A
$600

$400

$200

Project B

$0

22% 24% 26% 28% 30%

($86.39) ($130.65) ($170.34) ($205.97) ($237.98)

$26.71 ($1.11) ($26.85) ($50.72) ($72.88)

$0 0 -$200 0.05 0.1 0.15 0.2 0.25

Cost of Capital
-$400

c. What is each project's IRR? We find the internal rate of return with Excel's IRR function: IRR A = IRR B = 18.64% Note in the graph above that the X-axis intercepts are equal to the two projects' IRRs. 23.92%

d. What is the crossover rate, and what is its significance? Cash flow differential $200 ($490) ($390) ($290) $410 $410 $736 ($200)

Time 0 1 2 3 4 5 6 7

Crossover rate =

13.14%

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 value, at a cost of capital of 13.14% is: $182

e. What is each project's MIRR at a cost of capital of 12%? At r = 18%? (Hint: Consider Period 7 as the end of Project B's life.) @ 12% cost of capital MIRR A = MIRR B = 15.43% 17.01% @ 18% cost of capital MIRR A = MIRR B = 18.34% 20.47%

f. What is the regular payback period for these two projects? Project A Time period Cash flow Cumulative cash flow Payback Project B Time period Cash flow Cumulative cash flow Payback g. 0 (575) (575) 3.026 1 190 (385) 2 190 (195) 3 190 (5) 4 190 185 5 $190 375 6 $190 565 0 (375) (375) 4.625 1 (300) (675) 2 (200) (875) 3 (100) (975) 4 600 (375) 5 $600 225 6 $926 1,151

At a cost of capital of 12%, what is the discounted payback period for these two projects?

WACC = Project A

12%

Time period Cash flow Disc. cash flow Disc. cum. cash flow Discounted Payback Project B Time period Cash flow Disc. cash flow Disc. cum. cash flow Discounted Payback

0 (375) (375) (375) 5.40

1 (300) (268) (643)

2 (200) (159) (802)

3 (100) (71) (873)

4 600 381 (492)

5 $600 340 (152)

6 $926 469 317

0 (575) (575) (575) 3.98

1 190 170 (405)

2 190 151 (254)

3 190 135 (119)

4 190 121 2

5 $190 108 110

6 $190 96 206

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: $601.96 1.61 $781.17 1.36

ws are as follows:

, what

explained in this the range does not dded separately.

18 percent, then

ative to differing costs

0.3

st of Capital

ojects' IRRs.

e two projects mon net present

the end of

7 ($200) 951

7 $0 565

7 ($200) (90) 227

7 $0 0 206