Question

An investment project requires a net investment of $200 million. The project is expected to generate annual net cash flows of $25 million for the next 15 years with a one-time end of project cash flow of $3 million. The firm's cost of capital is 14 percent and marginal tax rate is 40 percent.

a) Evaluate the project using the NPV method and state whether or not the project should be accepted.

b) Evaluate the project using the IRR method and state whether or not the project should be accepted.

c) Evaluate the project using the PI method and state whether or not the project should be accepted.

Answers: NPV = -$46 million < 0 so Reject; IRR = 9.20 < 14% so Reject; PI = 0.77 < 1 so Reject

Please show the step by step formula included process for each part of the question! Thank you.

Answer 1

Calculation of NPV
						14.00%
Year					Annual Cash flow	PV factor	Present values
0					$            (200.00)	1.0000	$                 (200)
1					$               25.00	0.8772	$                     22
2					$               25.00	0.7695	$                     19
3					$               25.00	0.6750	$                     17
4					$               25.00	0.5921	$                     15
5					$               25.00	0.5194	$                     13
6					$               25.00	0.4556	$                     11
7					$               25.00	0.3996	$                     10
8					$               25.00	0.3506	$                       9
9					$               25.00	0.3075	$                       8
10					$               25.00	0.2697	$                       7
11					$               25.00	0.2366	$                       6
12					$               25.00	0.2076	$                       5
13					$               25.00	0.1821	$                       5
14					$               25.00	0.1597	$                       4
15					$               25.00	0.1401	$                       4
15					$                  3.00	0.1401	$                       0
					Net Present Value		$                   (46)
Since NPV is negative, hence reject
Calculation of IRR
			9.00%		10.00%
Year		Total cash flow	PV factor @ 9%	Present values	PV factor @ 10%	Present values
0		$            (200.00)	1.000	$            (200.00)	1.000	$           (200.00)
1		$               25.00	0.917	$               22.94	0.909	$               22.73
2		$               25.00	0.842	$               21.04	0.826	$               20.66
3		$               25.00	0.772	$               19.30	0.751	$               18.78
4		$               25.00	0.708	$               17.71	0.683	$               17.08
5		$               25.00	0.650	$               16.25	0.621	$               15.52
6		$               25.00	0.596	$               14.91	0.564	$               14.11
7		$               25.00	0.547	$               13.68	0.513	$               12.83
8		$               25.00	0.502	$               12.55	0.467	$               11.66
9		$               25.00	0.460	$               11.51	0.424	$               10.60
10		$               25.00	0.422	$               10.56	0.386	$                 9.64
11		$               25.00	0.388	$                  9.69	0.350	$                 8.76
12		$               25.00	0.356	$                  8.89	0.319	$                 7.97
13		$               25.00	0.326	$                  8.15	0.290	$                 7.24
14		$               25.00	0.299	$                  7.48	0.263	$                 6.58
15		$               25.00	0.275	$                  6.86	0.239	$                 5.98
15		$                  3.00	0.275	$                  0.82	0.239	$                 0.72
				$                  2.34		$               (9.13)
		IRR	=Lower rate + Difference in rates*(NPV at lower rate)/(Lower rate NPV-Higher rate NPV)
		IRR	'=9%+ (10%-9%)*(2.34082/(2.34082-(-9.1298)
			9.20%
Since IRR is 9.20% which is less than 14% so reject.
calculation of profitability index
PI=	Sum of PV of cash inflows/outflow
PI=	153.97/200
PI=	0.77
Since PI is less than 1 so reject