Question
In: Finance
Evaluate the following projects, using the net present value criteria. Assume a cost of capital of...
Evaluate the following projects, using the net present value criteria. Assume a cost of capital of 9%.
|
Project M |
Project N |
|
|
Initial Cash Outflow |
-$260,000 |
-$260,000 |
|
Year 1 Cash flow |
19,000 |
185,000 |
|
Year 2 Cash flow |
121,000 |
85,000 |
|
Year 3 Cash flow |
185,000 |
55,000 |
|
a. |
What are the NPVs for the projects and what do these numbers tell you? |
|
b. |
If the projects are independent, which would you accept according to the NPV criterion? |
|
c. |
If the projects are mutually exclusive, which would you accept according to the NPV criterion? |
|
d. |
Both projects have in total $325,000 of cash inflows and the same initial cash outflow. Why don't both projects have the same NPV? |
|
e. |
If the cost of capital increased to 12%, what impact would this have on your decision? |
|
f. |
Why does a change in the cost of capital have an impact on the NPV? |
Solutions
Expert Solution
Part A:
NPV = PV of Cash Inflows - PV of Cash Outflows
Project M:
| Year | CF | PVF @9% | Disc CF |
| 0 | $ -2,60,000.00 | 1.0000 | $ -2,60,000.00 |
| 1 | $ 19,000.00 | 0.9174 | $ 17,431.19 |
| 2 | $ 1,21,000.00 | 0.8417 | $ 1,01,843.28 |
| 3 | $ 1,85,000.00 | 0.7722 | $ 1,42,853.94 |
| NPV | $ 2,128.42 | ||
Project N:
| Year | CF | PVF @9% | Disc CF |
| 0 | $ -2,60,000.00 | 1.0000 | $ -2,60,000.00 |
| 1 | $ 1,85,000.00 | 0.9174 | $ 1,69,724.77 |
| 2 | $ 85,000.00 | 0.8417 | $ 71,542.80 |
| 3 | $ 55,000.00 | 0.7722 | $ 42,470.09 |
| NPV | $ 23,737.66 | ||
Part B:
If Projects are independent, Select the both projects, as the NPVs >0.
Part C:
If the projects are mutually exclsuive, select the project with higher NPV.
Project N is selected
Part D:
Because the CFs are different for both projects.
Project N has higher CFs in earlier years and Project M has higher CFs in later Years.
Part E:
Project M:
| Year | CF | PVF @12% | Disc CF |
| 0 | $ -2,60,000.00 | 1.0000 | $ -2,60,000.00 |
| 1 | $ 19,000.00 | 0.8929 | $ 16,964.29 |
| 2 | $ 1,21,000.00 | 0.7972 | $ 96,460.46 |
| 3 | $ 1,85,000.00 | 0.7118 | $ 1,31,679.35 |
| NPV | $ -14,895.91 | ||
Project N:
| Year | CF | PVF @12% | Disc CF |
| 0 | $ -2,60,000.00 | 1.0000 | $ -2,60,000.00 |
| 1 | $ 1,85,000.00 | 0.8929 | $ 1,65,178.57 |
| 2 | $ 85,000.00 | 0.7972 | $ 67,761.48 |
| 3 | $ 55,000.00 | 0.7118 | $ 39,147.91 |
| NPV | $ 12,087.96 | ||
Part F:
PVF for each rate will changed.
Higher cost of Capital - Lower NPV
Lower Cost of Capital - Higher NPV.
jeff jeffy answered 1 month agoRelated Solutions
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