Question

Your division is considering two projects. Its WACC is 10% (weighted average cost of capital, that represent a firm’s cost of capital in which each category of capital is proportionately weighted), the projects’ after-tax cash flows (in millions of dollars) would be as follows:

Project A

0 = - $30

1 = - $ 5

2 = $ 10

3 = $ 15

4 = 20

Project B

0 = - $ 30

1 = $ 20
2 = $10
3 = $8
4 = $6

Calculate the projects’ NPVs, IRRs and paybacks.

Answer 1

1.Project A

Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$30. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the weighted average cost of capital of 10%.
• Press the down arrow and CPT buttons to get the net present value.  

Net Present value of cash flows at 10% weighted average cost of capital is -$1.35.

Project B

Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$30. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the weighted average cost of capital of 10%.
• Press the down arrow and CPT buttons to get the net present value.  

Net Present value of cash flows at 10% weighted average cost of capital is $6.55.

2.Project A

Internal rate of return is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$30.It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of project is 8.56%.

Project B

Internal rate of return is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$30.It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of project is 22.52%.

3.Project A

Cash flow in year 1= $-5

Cumulative cash flow in year 2= $5

Cumulative cash flow in year 3= $20

Cumulative cash flow in year 4= $40

Payback period= full years until recovery + unrecovered cost at the start of the year/ cash flow during the year

= 3 years + ($30 - $20)/ $20

= 3 years + $10 / $20

= 3 years + 0.50

= 3.50 years.

Project B

Cash flow in year 1= $20

Cumulative cash flow in year 2= $10

Cumulative cash flow in year 2= $30

Payback period= full years until recovery + unrecovered cost at the start of the year/ cash flow during the year

= 2 years.

In case of any query, kindly comment on the solution.