Question
In: Finance
INSTRUCTIONS: Read the information below, including Parts a and b of Question 1. Create a new...
INSTRUCTIONS:
- Read the information below, including Parts a and b of Question 1.
- Create a new Excel spreadsheet. Record your answers to all parts of the question into the spreadsheet. Use bold text to clearly label your responses to Part a and Part b. Save your work regularly
(a) For the following mutually exclusive projects (A, B, C and D), find the Payback period, NPV, and IRR. The required rate of return is 11.00%.p.a. Assume all future cash flows only occur by the end of each year. Based on your results, which project should be accepted and why.
| Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 |
| A | -7,500 | 1,500 | 2,500 | 3,000 | 2000 | 1500 | 1,000 |
| B | -4,100 | 1200 | 1200 | 1200 | 1200 | 1200 | |
| C | -5,500 | 2,000 | 2,000 | 2,000 | 2,000 | ||
| D | -3,500 | 1,700 | 1,700 | 1,700 |
(b) AAA energy company is considering a project of solar energy plant. There are two different grades of solar panel under consideration. These two grades of solar panel come with different cost and efficiency. Grade A is the best in efficiency and lasts for 15 years with higher cost. Grade B is less efficient and lasts for 10 years, but the cost if lower. The company has already secured the land usage contract for the energy plant. The local government has granted the company free usage of the land as long as it operates as support for green energy and environment. The company intends to operate the project for infinite time, which means that the solar panels will be replaced once they reached their maximum useful life. The project team provided some estimated figures as below:
| Detail | Grade A | Grade B |
| Purchase Price | $545,000 | $350,000 |
| Yearly Revenue | $110,000 | $85,000 |
| Yearly Costs | ($12,000) | ($8,000) |
| Salvage Value | $10,000 | $9,000 |
| Useful Life | 15 years | 10 years |
Assuming it’s a perfect capital market that there are no taxes or
inflation, so the above figures won't change in the future. The
project team conducted a further analysis and provided some
information below:
Project beta 1.5, risk free rate 5%.p.a, and expected market return
11%.p.a.
Please complete the analysis for AAA energy company and provide
advice on the choice of solar panel.
Solutions
Expert Solution
| a] | PROJECT A: | ||||||||
| Year | Cash Flow | Cumulative Cash Flow | PVIF at 11% | PV at 11% | PVIF at 15% | PV at 15% | PVIF at 14% | PV at 14% | |
| 0 | $ (7,500) | $ (7,500) | 1 | $ (7,500) | 1 | $ (7,500) | 1 | $ (7,500) | |
| 1 | $ 1,500 | $ (6,000) | 0.90090 | $ 1,351 | 0.86957 | $ 1,304 | 0.87719 | $ 1,316 | |
| 2 | $ 2,500 | $ (3,500) | 0.81162 | $ 2,029 | 0.75614 | $ 1,890 | 0.76947 | $ 1,924 | |
| 3 | $ 3,000 | $ (500) | 0.73119 | $ 2,194 | 0.65752 | $ 1,973 | 0.67497 | $ 2,025 | |
| 4 | $ 2,000 | $ 1,500 | 0.65873 | $ 1,317 | 0.57175 | $ 1,144 | 0.59208 | $ 1,184 | |
| 5 | $ 1,500 | $ 3,000 | 0.59345 | $ 890 | 0.49718 | $ 746 | 0.51937 | $ 779 | |
| 6 | $ 1,000 | $ 4,000 | 0.53464 | $ 535 | 0.43233 | $ 432 | 0.45559 | $ 456 | |
| $ 816 | $ (11) | $ 183 | |||||||
| Payback period = 3+500/2000 = | 3.25 | Years | |||||||
| NPV = | $ 816 | ||||||||
| IRR = 15%-1%*11/(11+183) = | 14.94% | ||||||||
| PROJECT B: | |||||||||
| Payback period = 4100/1200 = | 3.42 | Years | |||||||
| NPV = -4100+1200*(1.11^5-1)/(0.11*1.11^5) = | $ 335 | ||||||||
| IRR: | |||||||||
| When discounted at IRR, | |||||||||
| 4100 = 1200*PVIFA(irr,5) | |||||||||
| PVIFA(irr,5) = 4100/1200 = | 3.4167 | ||||||||
| Annuity interest factors for 14% & | 14% | 15% | |||||||
| 15% for n = 5 are | 3.4331 | 3.3522 | |||||||
| IRR = 14%+1%*(3.4331-3.4167)/(3.4331-3.3522) = | 14.20% | ||||||||
| PROJECT C: | |||||||||
| Payback period = 5500/2000 | 2.75 | Years | |||||||
| NPV = -5500+2000*(1.11^4-1)/(0.11*1.11^4) = | $ 705 | ||||||||
| IRR: | |||||||||
| PVIFA(irr,4) = 5500/2000 = | 2.7500 | ||||||||
| 16% | 17% | ||||||||
| Annuity interest factors for 16% & | 2.7982 | 2.7432 | |||||||
| and 17% for n = 4 are = | |||||||||
| IRR = 16%+1%*(2.7982-2.75)/(2.7982-2.7432) = | 16.88% | ||||||||
| Project D: | |||||||||
| Payback period = 3500/1700 = | 2.06 | ||||||||
| NPV = -3500+1700*(1.11^3-1)/(0.11*1.11^3) = | $ 654 | ||||||||
| IRR: | |||||||||
| PVIFA(iir,3) = 3500/1700 = | 2.0588 | ||||||||
| Annuity interest factors for 21% & | 21% | 22% | |||||||
| 22% for n = 3 are | 2.0739 | 2.0422 | |||||||
| IRR = 21%+1%*(2.0739-2.0588)/(2.0739-2.0422) = | 21.48% | ||||||||
| TABULATION OF RESULTS AND RECOMMENDATION | |||||||||
| Project | Payback in Years | NPV | IRR | Life in years | PVIFA at 11% | EANPV | |||
| A | 3.25 | $ 816 | 14.94% | 6 | 4.23054 | $ 193 | |||
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