Question

A company is considering two mutually exclusive expansion plans. Plan A requires a $40 million expenditure on a large-scale integrated plant that would provide expected cash flows of $6.39 million per year for 20 years. Plan B requires a $13 million expenditure to build a somewhat less efficient, more labor-intensive plant with an expected cash flow of $2.91 million per year for 20 years. The firm's WACC is 9%.

A. Calculate each project's NPV. Round your answers to two decimal places. Do not round your intermediate calculations. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. ////Plan A: $ ____ million / Plan B: $ ____ million

B. Calculate each project's IRR. Round your answer to two decimal places. / Plan A: ____ % / Plan B: ____ %

C. By graphing the NPV profiles for Plan A and Plan B, approximate the crossover rate to the nearest percent. ____ %

D. Calculate the crossover rate where the two projects' NPVs are equal. Round your answer to two decimal places. / ____ %

E. Why is NPV better than IRR for making capital budgeting decisions that add to shareholder value? / ______

WACC	9.00%
(Dollars in Millions)		0	1	2	3	4	5	6	7	8	9	10	11	12	13	14	15	16	17	18	19	20
Plan A		($40.00)	$6.39	$6.39	$6.39	$6.39	$6.39	$6.39	$6.39	$6.39	$6.39	$6.39	$6.39	$6.39	$6.39	$6.39	$6.39	$6.39	$6.39	$6.39	$6.39	$6.39
Plan B		($13.00)	$2.91	$2.91	$2.91	$2.91	$2.91	$2.91	$2.91	$2.91	$2.91	$2.91	$2.91	$2.91	$2.91	$2.91	$2.91	$2.91	$2.91	$2.91	$2.91	$2.91

Answer 1

A.

year	Project A	Project B
0	-40	-13
1	6.39	2.91		rate	9%
2	6.39	2.91		NPV
3	6.39	2.91		A	$ 16.82
4	6.39	2.91		B	$ 12.44
5	6.39	2.91
6	6.39	2.91		FORMULA	=NPV (RATE,VALUES)
7	6.39	2.91
8	6.39	2.91
9	6.39	2.91
10	6.39	2.91
11	6.39	2.91
12	6.39	2.91
13	6.39	2.91
14	6.39	2.91
15	6.39	2.91
16	6.39	2.91
17	6.39	2.91
18	6.39	2.91
19	6.39	2.91
20	6.39	2.91

B.

year	Project A	Project B
0	-40	-13
1	6.39	2.91
2	6.39	2.91
3	6.39	2.91
4	6.39	2.91
5	6.39	2.91
6	6.39	2.91		IRR
7	6.39	2.91		A	15%
8	6.39	2.91		B	22%
9	6.39	2.91
10	6.39	2.91
11	6.39	2.91		FORMULA	=IRR(VALUES)
12	6.39	2.91
13	6.39	2.91
14	6.39	2.91
15	6.39	2.91
16	6.39	2.91
17	6.39	2.91
18	6.39	2.91
19	6.39	2.91
20	6.39	2.91

C.

NPV PROFILE
RATE	NPV (A)	NPV (B)
0%	$87.80	$45.20
2%	$64.49	$34.58
5%	$39.63	$23.27
7%	$27.70	$17.83
11%	$10.89	$10.17
12%	$7.73	$8.74
15%	-$0.00	$5.21
18%	-$5.80	$2.58
22%	-$11.50	-$0.02
APPROXIMATE CROSSOVER RATE				11%
FORMULA =NPV(RATE,CASH INFLOWS) - CASH OUTFLOWS

D

year	Project A	Project B	A-B
0	-40	-13	-27
1	6.39	2.91	3.48		CROSSOVER RATE	11.4%
2	6.39	2.91	3.48
3	6.39	2.91	3.48
4	6.39	2.91	3.48
5	6.39	2.91	3.48
6	6.39	2.91	3.48
7	6.39	2.91	3.48
8	6.39	2.91	3.48
9	6.39	2.91	3.48
10	6.39	2.91	3.48
11	6.39	2.91	3.48
12	6.39	2.91	3.48
13	6.39	2.91	3.48
14	6.39	2.91	3.48
15	6.39	2.91	3.48
16	6.39	2.91	3.48
17	6.39	2.91	3.48
18	6.39	2.91	3.48
19	6.39	2.91	3.48
20	6.39	2.91	3.48

E.

NPV is a better method for evaluating mutually exclusive projects than the IRR method.   The NPV method employs more realistic reinvestment rate assumptions, is a better indicator of profitability and shareholder wealth, and mathematically will return the correct accept-or-reject decision regardless of whether the project experiences non-normal cash flows or if differences in project size or timing of cash flows exist.