Question

In: Finance

As CFO of Gaga Inc., you are considering two projects, each with a cost of capital...

As CFO of Gaga Inc., you are considering two projects, each with a cost of capital of 11%, with the following cash flows:

t =               0   1     2     3      4    

Project S -6000 4000 3000 2000 1000

Project L -3500 2000 1000 2000 2000

  1. What is the NPV and IRR of Project S? (2 pts)  
  1. What is the NPV and IRR of Project L? (2 pts)
  1. Which project(s) should you choose if they are mutually exclusive and there is no capital rationing? Justify your answer using appropriate criterion. (1 pt)
  1. Which project should you choose if they are independent and there is severe capital rationing (such that you can only choose one)? Justify your answer using appropriate criterion. (1 pt)

Solutions

Expert Solution

Year Cash flows of Project S Discount factor@11% Present Value@11% Discount [email protected]% Present [email protected]% Cash flows of Project L Present Value@11% Discount [email protected]% Present [email protected]%
      -                              (6,000.00)                                1.00                       (6,000.00)                                  1.0000                             -6,000.00                            (3,500.00)                      (3,500.00)                                      1.00                             -3,500.00
1.00                              4,000.00                                0.90                         3,603.60                                  0.7612                               3,044.60                              2,000.00                        1,801.80                                      0.75                               1,492.31
2.00                              3,000.00                                0.81                         2,434.87                                  0.5794                               1,738.05                              1,000.00                           811.62                                      0.56                                  556.75
3.00                              2,000.00                                0.73                         1,462.38                                  0.4410                                  881.95                              2,000.00                        1,462.38                                      0.42                                  830.85
4.00                              1,000.00                                0.66                            658.73                                  0.3356                                  335.65                              2,000.00                        1,317.46                                      0.31                                  619.94
NPV                         2,159.58                                           -   NPV                        1,893.27                                           -  
IRR 31.38% 34.02%

Ans a. NPV and IRR of project S is $2159.58 and 31.38%.

Ans b. NPV and IRR of project L is $1893.27 and 34.02%.

Ans c. Since the projects are mutually exclusive and there is no capital rationing then both the projects can be selected as their NPV is positive.

Ans d. Since both the projects are independent and only one can be selected then select project S as its NPV is higher.


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