Question

Consider the following cash flows on two mutually exclusive projects for the Bahamas Recreation Corporation (BRC). Both projects require an annual return of 15%. Year Deepwater Fishing New Submarine Ride 0 -600,000 -1,800,000 1 270,000 1,000,000 2 350,000 700,000 3 300,000 900,000 as a financial analyst for BRC, you are asked the following questions: a. Based on the discounted payback period rule, which project should be chosen? b. If your decision rule is to accept the project with the greater IRR, which project should you use? c. Since you are fully aware of the IRR rule’s scale problem, you calculate the modified IRR (MIRR) for the two projects. Based on your computation, which project should you choose? d. To be prudent, you compute the NPV for both projects. Which project should you choose? Is it consistent with the MIRR rule?

no excel uses. please show all numbers in hand

please dont write any number without showing how u get to this number

Answer 1

Part a : Discounted Payback rule

Deepwater Fishing

Year 0 investment

600,000.00

Year	1	2	3
Cashinflows	270,000.00	350,000.00	300,000.00
PV factor @ 15% --> 1/(1+15%)^nth year	0.87	0.76	0.66
PV of Cashinflows	234,782.61	264,650.28	197,254.87
Cumulative PV of cashinflows	234,782.61	499,432.89	696,687.76

Step 1 : Monthly PV of Cashinflows of year 3	16,437.91
Step 2 : Additional cashinflow required - post year 2 (Initial capital outlay - cumulative cash inflows as on Year 2)	100,567
Step 3: Part of year 3 ---> Additional cashinfow required / monthly PV of Cashflows of year 3	6
Payback period (rounded to nearest month)	2 years 6 months

New Submarine Ride

Year 0 investment

1,800,000.00

Year	1	2	3
Cashinflows	1,000,000.00	700,000.00	900,000.00
PV factor @ 15% --> 1/(1+15%)^nth year	0.87	0.76	0.66
PV of Cashinflows	869,565.22	529,300.57	591,764.61
Cumulative PV of cashinflows	869,565.22	1,398,865.78	1,990,630.39

Step 1 : Monthly PV of Cashinflows of year 3	49,313.72
Step 2 : Additional cashinflow required - post year 2 (Initial capital outlay - cumulative cash inflows as on Year 2)	401,134
Step 3: Part of year 3 ---> Additional cashinfow required / monthly PV of Cashflows of year 3	8
Payback period (rounded to nearest month)	2 years 8 months

Based on discounted payback, project A needs to be selected as project A disc. Payback is lesser than project B disc. Payback.

Part b : IRR computation

Deepwater Fishing

NPV @ 20%

Year	0	1	2	3
Cashflows	(600,000.00)	270,000.00	350,000.00	300,000.00
PV factor @ 20% --> 1/(1+20%)^nth year	1.00	0.83	0.69	0.58
PV of cashflows --> Cashflows x PV factor	(600,000.00)	225,000.00	243,055.56	173,611.11
NPV	41,666.67

NPV @ 25%

Year	0	1	2	3
Cashflows	(600,000.00)	270,000.00	350,000.00	300,000.00
PV factor @ 25% ---> 1/(1+25%)^nth year	1.00	0.80	0.64	0.51
PV of cashflows ---> Cashflows x PV factor	(600,000.00)	216,000.00	224,000.00	153,600.00
NPV	(6,400.00)

NPV at lower discount rate	41,666.67
Lower discount rate	20.00%
NPV at higher discount rate	(6,400.00)
Higher discount rate	25.00%
Step 1 : Higher discount rate - Lower discount rate	5.00%
Step2 : NPV at lower discount rate x step1	2,083.33
Step3 : NPV at lower discount rate - NPV at higher discount rate	48,066.67
Step4 : Step2 / Step 3	4.33%
Step 5 : Lower discount rate + step4 ---IRR	24.33%

New Submarine Ride

NPV @ 20%

Year	0	1	2	3
Cashflows	(1,800,000.00)	1,000,000.00	700,000.00	900,000.00
PV factor @ 20% --> 1/(1+20%)^nth year	1.00	0.83	0.69	0.58
PV of cashflows ---> Cashflows x PV factor	(1,800,000.00)	833,333.33	486,111.11	520,833.33
NPV	40,277.78

NPV @ 25%

Year	0	1	2	3
Cashflows	(1,800,000.00)	1,000,000.00	700,000.00	900,000.00
PV factor @ 25% --> 1/(1+25%)^nth year	1.00	0.80	0.64	0.51
PV of cashflows ---> Cashflows x PV factor	(1,800,000.00)	800,000.00	448,000.00	460,800.00
NPV	(91,200.00)

NPV at lower discount rate	40,277.78
Lower discount rate	20.00%
NPV at higher discount rate	(91,200.00)
Higher discount rate	25.00%
Step 1 : Higher discount rate - Lower discount rate	5.00%
Step2 : NPV at lower discount rate x step1	2,013.89
Step3 : NPV at lower discount rate - NPV at higher discount rate	131,477.78
Step4 : Step2 / Step 3	1.53%
Step 5 : Lower discount rate + step4 ---IRR	21.53%

Since IRR of Deepwater fishing is higher than New submarine ride, Deep water fishing needs to be selcted

Part c : MIRR computation

Deepwater Fishing

FV of positive cashflows

Year	1	2	3
Cashflows	270,000.00	350,000.00	300,000.00
FV factor @ 15% ---> (1+15%)^(3-nth year)	1.32	1.15	1.00
FV of cashflows ---> Cashflows x FV factor	357,075.00	402,500.00	300,000.00
Total FV of positive cashflows	1,059,575.00

MIRR = (3rd root of (Total FV of positive cashflows / PV of negative cashflows)) - 1

MIRR = (3rd root of (1059575/ 600000)) - 1

MIRR = (3rd root of (1.7660)) - 1

MIRR = 1.2087 - 1

MIRR = 20.87%

New Submarine Ride

FV of positive cashflows

Year	1	2	3
Cashflows	1,000,000.00	700,000.00	900,000.00
FV factor @ 15% ---> (1+15%)^(3-nth year)	1.32	1.15	1.00
FV of cashflows ---> Cashflows x FV factor	1,322,500.00	805,000.00	900,000.00
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