Question

Sky Fly, Inc is a fast growing drone manufacturer. The annual rate of return of Sky Fly's stock has been 20% over the past few years. Company managers believe 20% is a good estimate for the firms' cost of capital. Sky Fly's CEO, Dane Cooper, believes the company needs to continue to invest in projects that offer the highest possible returns. Currently, the company is reviewing two separate projects. Project E involves expanding production capacity. Project I involves introducing one of the firms' drones into a new market. The following table shows the projected cash flows for each project.

Year	E	I
0	-3,500,000	-500,000
1	1,500,000	250,000
2	2,000,000	350,000
3	2,500,000	375,000
4	2,750,000	425,000

Discuss

Calculate the NPV, IRR, and PI for both projects.

Rank the projects based on their NPV, IRR, and PI.

The firm can only afford to take on one investment.

Which project will the CEO likely favor?

What do you think the company should do?

Explain your answers.

Answer 1

Year	E	I
0	$         -35,00,000.00	$         -5,00,000.00
1	$           15,00,000.00	$          2,50,000.00
2	$           20,00,000.00	$          3,50,000.00
3	$           25,00,000.00	$          3,75,000.00
4	$           27,50,000.00	$          4,25,000.00
NPV	$           1,911,844.14	$          373,360.34
IRR	43.70%	52.33%
PI	1.5462	1.7467

According to NPV select E
According to IRR Select I
PI - select I

CEO shall likely favor E as this will increase size of firm and his remuneration
Company shall select E as it adds more value to firm

IRR formulas:
=IRR(H11:H15)
where H11 to H15 are cash flows
PI = (Initial investmet +NPV)/Initial investment