Question

Coriander with a 14% WACC is evaluating two projects for this year’s capital budget. After-tax cash flows, including depreciation are as follows: Year Project A Project B O -$6000 -$18,000 1 $2000 $5,600 2 $2000 $5,600 3 $2000 $5,600 4 $2000 $5,600 5 $2000 $5,600 a. Calculate NPV and IRR for each project b. Assuming the projects are independent which one (s) would you recommend? c. If the projects are mutually exclusive, which would you recommend?

Answer 1

NPV = PV of Cash inflows - PV of Cash Outflows

Project A:

Year	CF	PVF @14%	Disc CF
0	$ -6,000.00	1.0000	$ -6,000.00
1	$   2,000.00	0.8772	$ 1,754.39
2	$   2,000.00	0.7695	$ 1,538.94
3	$   2,000.00	0.6750	$ 1,349.94
4	$   2,000.00	0.5921	$ 1,184.16
5	$   2,000.00	0.5194	$ 1,038.74
NPV			$     866.16

Project B:

Year	CF	PVF @14%	Disc CF
0	$ -18,000.00	1.0000	$ -18,000.00
1	$    5,600.00	0.8772	$    4,912.28
2	$    5,600.00	0.7695	$    4,309.02
3	$    5,600.00	0.6750	$    3,779.84
4	$    5,600.00	0.5921	$    3,315.65
5	$    5,600.00	0.5194	$    2,908.46
NPV			$    1,225.25

IRR : IRR is the rate at which PV of Cash Inflows are equal to PV of Cash Outflows.

Project A:

Year	CF	PVF @19%	Disc CF	PVF @20%	Disc CF
0	$ -6,000.00	1.0000	$ -6,000.00	1.0000	$ -6,000.00
1	$   2,000.00	0.8403	$ 1,680.67	0.8333	$ 1,666.67
2	$   2,000.00	0.7062	$ 1,412.33	0.6944	$ 1,388.89
3	$   2,000.00	0.5934	$ 1,186.83	0.5787	$ 1,157.41
4	$   2,000.00	0.4987	$     997.34	0.4823	$     964.51
5	$   2,000.00	0.4190	$     838.10	0.4019	$     803.76
NPV			$     115.27		$      -18.78

IRR = Rate at which least +ve NPV + [ NPV at that Rate / Change in NPV due to 1% inc in disc rate ] * 1%

= 19% + [ 115.27 / 134.05 ] * 1%

= 19% + 0.86%

= 19.86%

Project B:

Year	CF	PVF @16%	Disc CF	PVF @17%	Disc CF
0	$ -18,000.00	1.0000	$ -18,000.00	1.0000	$ -18,000.00
1	$    5,600.00	0.8621	$    4,827.59	0.8547	$    4,786.32
2	$    5,600.00	0.7432	$    4,161.71	0.7305	$    4,090.88
3	$    5,600.00	0.6407	$    3,587.68	0.6244	$    3,496.48
4	$    5,600.00	0.5523	$    3,092.83	0.5337	$    2,988.44
5	$    5,600.00	0.4761	$    2,666.23	0.4561	$    2,554.22
NPV			$        336.04		$        -83.66

IRR = Rate at which least +ve NPV + [ NPV at that Rate / Change in NPV due to 1% inc in disc rate ] * 1%

= 16% + [ 336.04 / 419.71 ] * 1%

= 16% + 0.8%

= 16.80%Part C:

If projects are mutually exclusive, select the project with higher NPV.

Project B is selected.