Question

Project A and Project B have a cost of $30,000,000 today. Project A will have cash flows of $12,000,000 per year for three years, while Project B will have cash flows of $15,000,000 the first year, $10,000,000 the second year, and $11,000,000 the third year.

1. Calculate the NPV and the IRR for Project A using a 10% cost of capital and show your work by using TWO of the following methods: (1) using the formula, (2) identifying all variables using the calculator’s function keys, (3) using the steps on the calculator to calculate NPV and IRR. SHOW WORK

2. Calculate the NPV and the IRR for Project B using a 10% cost of capital and show your work by using TWO of the following methods: (1) using the formula, (2) identifying all variables using the calculator’s function keys, (3) using the steps on the calculator to calculate NPV and IRR. SHOW WORK

3. Should A, B, both A and B, or neither be accepted if the projects are independent. Circle your choice

4. Should A, B, both A and B, or neither be accepted if the projects are mutually exclusive. Circle your choice

Answer 1

NPV=Present value of future cash inflows-Cash ouflow

Project A, NPV=((12000000/(1+10%))+(12000000/(1+10%)^2)+(12000000/(1+10%)^3))-30,000,000

Project A, NPV=-157,776.11

We can also use EXCEL

NPV(rate, values)

NPV(rate, year1 to year3 cashflows)-Cash outflow

NPV(10%,Year1 to Year3 cashflows)-30,000,000

NPV=-157,776.11

IRR can be used with function in EXCEL

IRR, Project A=IRR(values)=IRR(cashflows from Year 0 to Year3)=9.70%

In similar way, NPV and IRR for Project B can be solved

NPV, Project B=(15000000/(1+10%))+(10000000/(1+10%)^2)+(11000000/(1+10%)^3))-30,000,000

NPV, Project B=165,289.26

IRR, Project B=IRR(Year 0 to Year3 cahflows)=10.33%

3. If projects are independent: We have select only Project B because of positive NPV and IRR>cost of capital. Despite projects are independent, we should not select Project A because it eats way the shareholders wealth because of negative NPV

4. If projects are mutually exclusive: We should select only Project B and avoid Project A. Project B increases the shareholders wealth