Question

Wii Brothers, a game manufacturer, has a new idea for an adventure game. It can market the game either as a traditional board game or as an interactive DVD, but not both. Consider the following cash flows of the two mutually exclusive projects for the company. Assume the discount rate is 12 percent.

  

Year	Board Game			DVD
0	–$	1,450		–$	3,200
1		740			2,000
2		1,200			1,620
3		260			1,050

  

a.	What is the payback period for each project? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

  

	Payback period
Board game	years
DVD	years

    

b.	What is the NPV for each project? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

  

	NPV
Board game	$
DVD	$

  

c.	What is the IRR for each project? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

  

	IRR
Board game	%
DVD	%

    

d.	What is the incremental IRR? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

  

Incremental IRR

%

Answer 1

a.

	Payback period
Board game	1.82 years
DVD	1.74 years

Explanation:

	Board Game		DVD
Year	Cash Flow CB	‘CUM Cash Flow	Cash Flow CD	‘CUM Cash Flow
0	($1,450)	($1,450)	($3,200)	($3,200)
1	$470	($980)	$2,000	($1,200)
2	$1,200	$220	$1,620	$420
3	$260	$480	$1,050	$1,470

Payback Period = A +B/C

Where,

A = Last period with a negative cumulative cash flow

B = Absolute value of cumulative cash flow at the end of the period A

C = Total cash flow during the period after A

Payback Period Board game = 1 +│$ (980) │/$ 1,200

                           = 1+ ($ 980/$1,200) = 1 + 0.816667 = 1.82 years

Payback Period DVD = 1 +│$ (1,200) │/$ 1,620

                           = 1+ ($ 1,200/$1,620) = 1 + 0.740741 = 1.74 years

b.

	NPV
Board game	$ 111.34
DVD	$ 624.54

Explanation:

	Board Game	DVD			Board Game	DVD
Year	Cash Flow CB	Cash Flow CD	PV Factor Calculation	PV Factor F @ 12%	PV (= CB x F)	PV (= CD x F)
0	($1,450)	($3,200)	1/(1+0.12)^0	1	($1,450.00)	($3,200.00)
1	$470	$2,000	1/(1+0.12)^1	0.892857143	$419.64	$1,785.71
2	$1,200	$1,620	1/(1+0.12)^2	0.797193878	$956.63	$1,291.45
3	$260	$1,050	1/(1+0.12)^3	0.711780248	$185.06	$747.37
				NPV	$111.34	$624.54

c.

	IRR
Board game	16.59%
DVD	24.40%

Explanation:

Year	Cash Flow CBBoard Game	Cash Flow CD DVD
0	($ 1,450)	($ 3,200)
1	$     470	$   2,000
2	$ 1,200	$   1,620
3	$    260	$   1,050
IRR	16.59%	24.40%

Excel formula for IRR is “= IRR(Cell no:Cell no)

d.

Incremental IRR

31.69 %

Explanation:

Year	Incremental Cash Flow (CD – CB)
0	($ 1,750)
1	$ 1,530
2	$     420
3	$     790
IRR	31.69%

Excel formula for Incremental IRR is “= IRR(Cell no:Cell no)

Based on Payback period, NPV and IRR, Project DVD should be preferred.

Also incremental IRR suggests Project DVD, as the incremental IRR is higher than company’s discount rate project with higher investment should be selected.