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NPV Model

The document summarizes the analysis of two investment projects, Projects A and B, based on their expected net cash flows over 7 years. At a 12% cost of capital, Project A has a higher NPV of $226.96 and should be selected. However, at an 18% cost of capital, Project B has a higher NPV of $89.54. The internal rates of return are 18.64% for Project A and 23.92% for Project B. The crossover rate, where the NPVs are equal, is 13.14%.

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Camilo Lacouture
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227 views6 pages

NPV Model

The document summarizes the analysis of two investment projects, Projects A and B, based on their expected net cash flows over 7 years. At a 12% cost of capital, Project A has a higher NPV of $226.96 and should be selected. However, at an 18% cost of capital, Project B has a higher NPV of $89.54. The internal rates of return are 18.64% for Project A and 23.92% for Project B. The crossover rate, where the NPVs are equal, is 13.14%.

Uploaded by

Camilo Lacouture
Copyright
© © All Rights Reserved
Available Formats
Download as XLS, PDF, TXT or read online on Scribd
Download as xls, pdf, or txt
Download as xls, pdf, or txt
You are on page 1/ 6

4/11/2010

Chapter 10. Solution for Chapter 10 P23 Build a Model


Gardial Fisheries is considering two mutually exclusive investments. The projects' expected net cash flows are as
follows:

Time
0
1
2
3
4
5
6
7

Expected Net Cash Flows


Project A Project B
($375)
($575)
($300)
$190
($200)
$190
($100)
$190
$600
$190
$600
$190
$926
$190
($200)
$0

a. If each project's cost of capital is 12%, which project should be selected? If the cost of capital is 18%, what
project is the proper choice?
@ 12% cost of capital

@ 18% cost of capital

WACC =

WACC =

NPV A =

$226.96

NPV A =

Use Excel's NPV function as explained in this


18% chapter's Tool Kit. Note that the range does not
include the costs, which are added separately.
$18.24

NPV B =

$206.17

NPV B =

$89.54

12%

At a cost of capital of 12%, Project A should be selected. However, if the cost of capital rises to 18%, then the choice is
reversed, and Project B should be accepted.
b. Construct NPV profiles for Projects A and B.
Before we can graph the NPV profiles for these projects, we must create a data table of project NPVs relative to
differing costs of capital.

0%
2%
4%
6%
8%
10%
12%
14%
16%
18%

Project A
$226.96
$951.00
$790.31
$648.61
$523.41
$412.58
$314.28
$226.96
$149.27
$80.03
$18.24

Project B
$206.17
$565.00
$489.27
$421.01
$359.29
$303.35
$252.50
$206.17
$163.85
$125.10
$89.54

NPV

NPV Profiles

$1,000.00

$800.00

Project A
$600.00

$400.00

Project B

$200.00

$0.00
-5%
($200.00)

0%

5%

10%

15%

20%

25%

Cost of Capital

30%

$600.00

$400.00

$200.00

20%
22%
24%
26%
28%
30%

($36.98)
($86.39)
($130.65)
($170.34)
($205.97)
($237.98)

$56.85
$26.71
($1.11)
($26.85)
($50.72)
($72.88)

$0.00
-5%

0%

5%

10%

15%

($200.00)

20%

25%

30%

Cost of Capital

($400.00)

c. What is each project's IRR?

We find the internal rate of return with Excel's IRR function:


IRR A =
IRR B =

18.64% Note in the graph above that the X-axis intercepts are equal to the two projects' IRRs.
23.92%

d. What is the crossover rate, and what is its significance?

Time
0
1
2
3
4
5
6
7

Cash flow
differential
$200
($490)
($390)
($290)
$410
$410
$736
($200)

Crossover rate =

13.14%

The crossover rate represents the cost of capital at which the two projects
have the same net present value. In this scenario, that common net present
value, at a cost of capital of 13.14% is:
$182

e. What is each project's MIRR at a cost of capital of 12%? At r = 18%? (Hint: Consider Period 7 as the end of
Project B's life.)
@ 12% cost of capital

@ 18% cost of capital

MIRR A =
MIRR B =

MIRR A =
MIRR B =

15.43%
17.01%

18.34%
20.47%

f. What is the regular payback period for these two projects?


Project A
Time period
Cash flow
Cumulative cash flow
Payback

0
(375)
(375)
4.625

1
(300)
(675)

2
(200)
(875)

3
(100)
(975)

4
600
(375)

5
$600
225

6
$926
1,151

7
($200)
951

0
(575)
(575)
3.026

1
190
(385)

2
190
(195)

3
190
(5)

4
190
185

5
$190
375

6
$190
565

7
$0
565

Project B
Time period
Cash flow
Cumulative cash flow
Payback

g. At a cost of capital of 12%, what is the discounted payback period for these two projects?

WACC =

12%

Project A
Time period
Cash flow
Disc. cash flow
Disc. cum. cash flow
Discounted Payback

0
(375)
(375)
(375)
5.40

1
(300)
(268)
(643)

2
(200)
(159)
(802)

3
(100)
(71)
(873)

4
600
381
(492)

5
$600
340
(152)

6
$926
469
317

7
($200)
(90)
227

0
(575)
(575)
(575)
3.98

1
190
170
(405)

2
190
151
(254)

3
190
135
(119)

4
190
121
2

5
$190
108
110

6
$190
96
206

7
$0
0
206

Project B
Time period
Cash flow
Disc. cash flow
Disc. cum. cash flow
Discounted Payback

h. What is the profitability index for each project if the cost of capital is 12%?
PV of future cash flows for A:
PI of A:

$601.96
1.61

PV of future cash flows for B:


PI of B:

$781.17
1.36

end of

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