Question

Medical Technology Enterprises is trying to select the best investment from among four alternatives. The company’s cost of capital (CCC) is 14%. The initial cost and future cash flows of the alternatives are presented below.

  

Year	Alternative A ($)	Alternative B (S)	Alternative C ($)	Alternative D ($)
0	-200,000	-200,000	-200,000	-200,000
1	70,000	0	60,000	90,000
2	80,000	0	60,000	100,000
3	70,000	90,000	60,000	100,000
4	40,000	100,000	60,000	0
5	30,000	100,000	60,000	0

(If you are not submitting an Excel file, PLEASE SHOW YOUR WORK for parts C, E, and G)

A) Calculate the Payback period for each alternative and complete the following table (round to two decimal places):

	Alternative A	Alternative B	Alternative C	Alternative D
Payback period

B) Which of the alternatives would you select under the payback method? Please explain why.

C) Calculate the net present value (NPV) for each alternative and complete the following table (round to whole numbers):

	Alternative A	Alternative B	Alternative C	Alternative D
NPV

D) Which of the alternative would select under the net present value? Please explain why.

E) Calculate the internal rate of return (IRR) for each alternative and complete the following table (round to two decimal places):

	Alternative A	Alternative B	Alternative C	Alternative D
IRR

F) Which of the alternative would you select under the internal rate of return? Please explain why.

           

G) Calculate the modified internal rate of return (MIRR) for each alternative and complete the following table (round to two decimal places):

	Alternative A	Alternative B	Alternative C	Alternative D
MIRR

H) Which of the alternative would you select under the modified internal rate of return? Please explain why.

Answer 1

(a) Payback period is the period in which the cash flows turn positive

Let us find the cumulative cash flows -

Payback for A = 2 + 50000/70000 = 2.71 years
Payback for B = 4 + 10000/100000 = 4.10 years
Payback for C = 3 + 20000/60000 = 3.33 years
Payback for D = 2 + 10000/100000 = 2.10 years

(b) Alternative D is the best since it has the lowest payback

(c) NPV is the sum of Present Value of all Cash Flows

NPV = Σ CF_n * PV Factor_n

Where, CFⁿ is the cash flow for period n and PV Factor = 1/(1+r)ⁿ

Given Cost of Capital r = 14%

Calculating NPV -

Hence,

NPV for Alternative A = 9473.19
NPV for Alternative B = -28107.67
NPV for Alternative C = 5984.86
NPV for Alternative D = 23391.27

(d) Since Project D has the highest NPV, Project D should be selected.

(e) IRR is the rate at which NPV = 0

Calculating using excel function = IRR(cash flows)

IRR for Alternative A = 16.25%
IRR for Alternative B = 9.72%
IRR for Alternative C = 15.24%
IRR for Alternative D = 20.72%

(f) Projects with IRR>cost of capital (14%) should be selected

Hence, project A, C, D should be selected.