Question

In: Finance

Last Tuesday, Green Caterpillar Garden Supplies Inc. lost a portion of its planning and financial data...

Last Tuesday, Green Caterpillar Garden Supplies Inc. lost a portion of its planning and financial data when both its main and its backup servers crashed. The company’s CFO remembers that the internal rate of return (IRR) of Project Gamma is 13.2%, but he can’t recall how much Green Caterpillar originally invested in the project nor the project’s net present value (NPV). However, he found a note that detailed the annual net cash flows expected to be generated by Project Gamma. They are:

Year

Cash Flow

Year 1 $2,400,000
Year 2 $4,500,000
Year 3 $4,500,000
Year 4 $4,500,000

The CFO has asked you to compute Project Gamma’s initial investment using the information currently available to you. He has offered the following suggestions and observations:

A project’s IRR represents the return the project would generate when its NPV is zero or the discounted value of its cash inflows equals the discounted value of its cash outflows—when the cash flows are discounted using the project’s IRR.
The level of risk exhibited by Project Gamma is the same as that exhibited by the company’s average project, which means that Project Gamma’s net cash flows can be discounted using Green Caterpillar’s 9% WACC.

Given the data and hints, Project Gamma’s initial investment is _________ , and its NPV is ____________ (rounded to the nearest whole dollar).

A project’s IRR will _________ if the project’s cash inflows decrease, and everything else is unaffected.

Solutions

Expert Solution

Initial Investment

The question has given he Internal Rate of Return [IRR] as 13.20%, IRR is the rate at which the present value of the annual cash flow equals to the initial Investment or it can say that at IRR, the present value of the annual cash flow = Initial Investment, or at IRR, NPV will be Zero

Initial Investment = Present Value of the annual cash inflows discounted at 13.20%

Year

Annual Cash Flow

Present Value factor at 13.20%

Present Value of Cash Flow

1

24,00,000

0.8833922

21,20,141

2

45,00,000

0.7803818

35,11,718

3

45,00,000

0.6893832

31,02,225

4

45,00,000

0.6089958

27,40,481

TOTAL

1,14,74,565

“Therefore, the Initial Investment is $1,14,74,565 “

Net Present Value (NPV)

Year

Annual Cash Flow

Present Value factor at 9.00%

Present Value of Cash Flow

1

24,00,000

0.9174312

22,01,835

2

45,00,000

0.8416800

37,87,560

3

45,00,000

0.7721835

34,74,826

4

45,00,000

0.7084252

31,87,913

TOTAL

1,26,52,134

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $1,26,52,134 - $1,14,74,565

= $11,77,569

“The Net Present Value (NPV) will be $11,77,569”

Given the data and hints, Project Gamma’s Initial Investment is $1,14,74,565 and it’s NPV is $11,77,569”

A Project’s IRR will “DECREASE” if the Project’s cash flows decreases, and everything else is unaffected.

NOTE    

The Formula for calculating the Present Value Factor is [1/(1 + r)n], Where “r” is the Discount/Interest Rate and “n” is the number of years.


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