Chapter 12.

Chapter 12 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 you were told that each project's cost of capital was 12 percent, which project should be selected? If the cost of capital was 18 percent, what would be the proper choice? @ a 12% cost of capital WACC = NPV A = NPV B = 12% @ a 18% cost of capital WACC = NPV A = NPV B = 18% Use Excel's NPV function as explained in this chapter's Tool Kit. Note that the range does not include the costs, which are added separately.

At a cost of capital of 12%, Project A should be selected. However, if the cost of capital rises to 18%, then the choice is reversed, and Project B should be accepted. 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 NPV relative to differing costs of capital. r 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 22% Project A Project B

24% 26% 28% 30% c. What is each project's IRR? We find the internal rate of return with Excel's IRR function: IRR A = IRR B = Note in the graph above that the X-axis intercepts are equal to the two projects' IRRs.

e. What is the crossover rate, and what is its significance? Cash flow differential

Time 0 1 2 3 4 5 6 7

Crossover rate = 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 13.13%, is:

d. What is each project's MIRR at a cost of capital of 12 percent? At r = 18%? (Hint: Consider Period 7 to be the end of Project B's life.) @ a 12% cost of capital MIRR A = MIRR B = @ a 18% cost of capital MIRR A = MIRR B =

f. What is the regular payback period for these two projects? Project A Time period: Cash flow: Cumulative cash flow: % of year required for payback: Max Row 93=Payback: 0 (375) 1 (300) 2 (200) 3 (100) 4 600 5 $600 6 $926

Project B Time period: Cash flow: Cumulative cash flow: % of year required for payback: Payback: 0 (575) 1 190 2 190 3 190 4 190 5 $190 6 $190

g.

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

WACC = Project A

Time period: Cash flow: Disc. cash flow: Disc. cum. cash flow: % of year required for payback: Discounted Payback:

0 (375)

1 (300)

2 (200)

3 (100)

4 600

5 $600

6 $926

Project B Time period: Cash flow: Disc. cash flow: Disc. cum. cash flow: % of year required for payback: Discounted Payback: 0 (575) 1 190 2 190 3 190 4 190 5 $190 6 $190

h. What is the profitability index for each project if the cost of capital is 12 percent? PV of future cash flows for A: PI of A: PV of future cash flows for B: PI of B:

s explained in this at the range does not added separately.

iffering costs of

two projects' IRRs.

the end of Project

7 ($200)

7 $0

7 ($200)

7 $0