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 10%. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below.

1. 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

   Calculate each project's IRR. Round your answer to two decimal places.

   Plan A: %

   Plan B: %

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

   %

3. Calculate the crossover rate where the two projects' NPVs are equal. Round your answer to two decimal places.

   %

4. Why is NPV better than IRR for making capital budgeting decisions that add to shareholder value? The input in the box below will not be graded, but may be reviewed and considered by your instructor.

Answer 1

a)

Project A - 14.40

Project B - 13.61

(you can see the formula for NPV in the formula bar above for Plan A.for Plan B also same formula)

IRR:

Plan A - 15.00%

Plan B - 21.98%

b)

graph:

you can see the both lines intersect at just after 10%

so answer is 10%

c)

cross over rate:

to calculate cross over rate first we have to deduct plan A cashflows from Plan B cash flows

initial investment = -40-(-15) = -25

cash inflows = 6.39 - 3.36 = 3.03

and cross over rate can be find using IRR formula (same as above)

so cross over rate = 10.46%

d)

NPV is better than IRR because IRR does not consider the magnitude of the cash flows.if we look at both Plans Plan B has higher IRR but Plan A has high NPV i.e., net cash flows after discounting will be more under Plan A.it adds more wealth to the share holders.