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 $15 million expenditure to build a somewhat less efficient, more labor-intensive plant with an expected cash flow of $3.36 million per year for 20 years. The firm's WACC is 11%.

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

   Plan A:     $   million

   Plan B:     $   million

   Calculate each project's IRR. Round your answers to one decimal place.

   Plan A:     %

   Plan B:     %

2. By graphing the NPV profiles for Plan A and Plan B, determine the crossover rate. Round your answer to the nearest whole number.
   %
   
3. Calculate the crossover rate where the two projects' NPVs are equal. Round your answer to one decimal place.
   %
   
4. Is NPV better than IRR for making capital budgeting decisions that add to shareholder value?
   -Select-YesNo

Answer 1

a&c. Calculated and mentioned in the below sheet

NPV can be calculated using NPV function in EXCEL

=NPV(rate,Year1 to Year20 cashflows)-Initial cost

NPV of Plan A=NPV(11%,Year1 to Year 20 cashflows)-40,000,000=$10,885,666.67

NPV for Plan B=NPV(11%, Year1 to Year20 cashflows)-15,000,000=$11,756,782.47

IRR formula in EXCEL is

=IRR(Values)

IRR for Plan A=IRR(Year0 to Year 20 cashflows)=15.0%

IRR for plan B=IRR(Year0 to Year 20 cashflows)=22.0%

Cross over rate is the rate at which two NPVs are equal.

For this we have to subtract Plan B from Plan A

Cost=$40,000,000-$15,000,000=$25,000,000

Year1 to Year 20=$6390000-3360000=$3030000

Cross over rate=IRR (vales)=IRR(Year0 to Year20 cashflows)=10.46%

b. Graph of NPVs of Plan A and B also depicts the same rate.

d. True.

NPV is better because the value will be added to shareholders wealth and IRR fluctuates during the tenure of the project based on the changes in market conditions