Question

A firm with a 13% WACC is evaluating two projects for this year's capital budget. After-tax cash flows, including depreciation, are as follows:

0

1

2

3

4

5

Project M	-$6,000	$2,000	$2,000	$2,000	$2,000	$2,000
Project N	-$18,000	$5,600	$5,600	$5,600	$5,600	$5,600

1. Calculate NPV for each project. Do not round intermediate calculations. Round your answers to the nearest cent.

   Project M:    $  

   Project N:    $  

   Calculate IRR for each project. Do not round intermediate calculations. Round your answers to two decimal places.

   Project M:       %

   Project N:       %

   Calculate MIRR for each project. Do not round intermediate calculations. Round your answers to two decimal places.

   Project M:       %

   Project N:       %

   Calculate payback for each project. Do not round intermediate calculations. Round your answers to two decimal places.

   Project M:      years

   Project N:      years

   Calculate discounted payback for each project. Do not round intermediate calculations. Round your answers to two decimal places.

   Project M:      years

   Project N:      years

2. Assuming the projects are independent, which one(s) would you recommend?

   -Select-Only Project M would be accepted because NPV(M) > NPV(N).Only Project N would be accepted because NPV(N) > NPV(M).Both projects would be accepted since both of their NPV's are positive.Only Project M would be accepted because IRR(M) > IRR(N).Both projects would be rejected since both of their NPV's are negative.Item 11

3. If the projects are mutually exclusive, which would you recommend?

   -Select-If the projects are mutually exclusive, the project with the highest positive NPV is chosen. Accept Project N.If the projects are mutually exclusive, the project with the highest positive IRR is chosen. Accept Project M.If the projects are mutually exclusive, the project with the highest positive MIRR is chosen. Accept Project M.If the projects are mutually exclusive, the project with the shortest Payback Period is chosen. Accept Project M.If the projects are mutually exclusive, the project with the highest positive IRR is chosen. Accept Project N.Item 12

4. Notice that the projects have the same cash flow timing pattern. Why is there a conflict between NPV and IRR?

Answer 1

Based on the given data, pls find below workings, steps and answers;

Answers for (a) mentioned and highlighted in yellow in the screenshot below:

b) If these Projects are independent, Both projects would be accepted since both of their NPV's are positive and also all other variables like IRR and Payback period also favouring;

c) If the projects are mutually exclusive, the project with the highest positive NPV is chosen. Accept Project N.

In this case there shall be a clash of ranking between IRR and NPV; However, since the NPV is the absolute value and is the direct value addition interms of dollar value, the perference shall be given for NPV over IRR or any other technique.

d) Notice that the projects have the same cash flow timing pattern. Why is there a conflict between NPV and IRR?

Although the projects have same life period and the pattern of cash flows, the initial outlay at Year 0 is different for these two and the time value of the future cash flow shall also impact the overal NPV of the Project. And IRR counts on the initial outflow and the Return expected from the projected cash flows;

Computation of IRR: This can be computed using formula in Excel = IRR("range of cashflows", discounting factor%);

Computation of MIRR: This can be computed using formula in Excel = IRR("range of cashflows", discounting factor%, reinvestment factor%); Here, both discounting factor % and reinvestment factor% are considered same.

Computation of Net Present Value (NPV) based on the Discounted Cash flows; The Discounting factor is computed based on the formula: For year 0, the discounting factor is 1; For Year 1, it is computed as = Year 0 factor /(1+discounting factor%) ; Year 2 = Year 1 factor/(1+discounting factor %) and so on;

Next, the cashflows need to be multiplied with the respective years' discounting factor, to arrive at the discounting cash flows;

The total of all the discounted cash flows is equal to its respective Project NPV of the Cash Flows;

Computation of Pay Back Period: Here, the period is computed for each project, based on cumulative discounted cash flows: If the cumulative value is less than or equal to zero, the period is considered as 12 months (it means that the net cumulative cash flow has not yet paid back the initial investment); Once the value turns positive in a particular year, the period for such year is observed at a proportion of actual discounted cash flow to the cumulative CF; This gives the period less than 12 months in such year; Once this is computed, total of all the years is taken and divided by 12, to arrive at the Payback period in no.of years.