Question

8. Project R has a cost of $ 10,000 and in expected to produce cash flows per year of $ 4,000 for 3 years. Project S has a cost of $20,000 and in expected to produce cash flows of $ 7,000 per year for 4 years. Calculate the 2 projects' NPVs, IRRs, MIRRs, and PIs, assuming a cost of capital of 11%. Which project should be selected ?

Answer 1

NPV

NPV = (-)Initial Investment + Cash inflows x PVIFA (11%, years)

Project R = (-)$10,000 + $4,000 x PVIFA (11% , 3) = (-)$10,000 + $4,000 x 2.44371471543 = (-)$225.1411383 or (-)$225.14

Project S = (-)$20,000 + $7,000 x PVIFA (11% , 4) = (-)$20,000 + $7,000 x 3.10244568956 = $1,717.1198269 or $1,717.12

On the basis on NPV, project S seems more attractive as it has a positive NPV.

IRR

Project R

Project S

Projects having IRR higher than the cost of capital or minimum required return should be accepted. Therefore, Project S should be selected on the basis of IRR.

MIRR

Project R

Project S

MIRR has the rule of higher is better. Therefore, Project S should be selected as per MIRR.

PI

Profitability Index (PI) = Present value of cash Inflows / intial investment

Project R = ($4000 x 2.44371471543) / $10,000 = 0.977486 or 0.98

Project S = ($7000 x 3.10244568956) / $20,000 = 1.085856 or 1.09

Every project PI of 1 or greater should be accepted. Therefore, Project S should be selected on the basis of PI.

From the all the above results, it is clear that Project S should be selected.