CASE STUDY CONTINUATION
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2. Suppose that the two streams are combined into one project, called C. What is the IRR of Project C?
3. What is the correct IRR rule for Project C?
27. Calculating Incremental Cash Flows Darin Clay, the CFO of MakeMoney.com, has to decide between the following two projects:
YearProject MillionProject Billion 0 −$1,200 −$Io 1 Io + 160 Io + 400 2 960 1,200 3 1,200 1,600
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The expected rate of return for either of the two projects is 12 percent. What is the range of initial investment (Io) for which Project Billion is more financially attractive than Project Million?
28. Problems with IRR McKeekin Corp. has a project with the following cash flows:
YearCash Flow 0 $20,000 1 −26,000 2 13,000
What is the IRR of the project? What is happening here?
Excel Master It! Problem
As you have already seen, Excel does not have a function to calculate the payback period. We have shown three ways to calculate the payback period, but there are numerous other methods as well. The cash flows for a project are shown below. You need to calculate the payback period using two different methods:
1. Calculate the payback period in a table. The first three columns of the table will be the year, the cash flow for that year, and the cumulative cash flow. The fourth column will show the whole year for the payback. In other words, if the payback period is 3 plus years, this column will have a 3, otherwise it will be a zero. The next column will calculate the fractional part of the payback period, or else it will display zero. The last column will add the previous two columns and display the final payback period calculation. You should also have a cell that displays the final payback period by itself, and a cell that returns the correct accept or reject decision based on the payback criteria.
2. Write a nested IF statement that calculates the payback period using only the project cash flow column. The IF statement should return a value of “Never” if the project has no payback period. In contrast to the example we showed previously, the nested IF function should test for the payback period starting with shorter payback periods and working towards longer payback periods. Another cell should display the correct accept or reject decision based on the payback criteria.
Year Cash Flow 0 −$250,000 1 41,000 2 48,000 3 63,000 4 79,000 5 88,000 6 64,000 7 41,000 Required payback: 5
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Page 170 Mini Case BULLOCK GOLD MINING
Seth Bullock, the owner of Bullock Gold Mining, is evaluating a new gold mine in South Dakota. Dan Dority, the company’s geologist, has just finished his analysis of the mine site. He has estimated that the mine would be productive for eight years, after which the gold would be completely mined. Dan has taken an estimate of the gold deposits to Alma Garrett, the company’s financial officer. Alma has been asked by Seth to perform an analysis of the new mine and present her recommendation on whether the company should open the new mine.
Alma has used the estimates provided by Dan to determine the revenues that could be expected from the mine. She has also projected the expense of opening the mine and the annual operating expenses. If the company opens the mine, it will cost $850 million today, and it will have a cash outflow of $75 million nine years from today in costs associated with closing the mine and reclaiming the area surrounding it. The expected cash flows each year from the mine are shown in the following table. Bullock Mining has a 12 percent required return on all of its gold mines.
Year Cash Flow 0 −$850,000,000 1 170,000,000 2 190,000,000 3 205,000,000 4 265,000,000 5 235,000,000 6 170,000,000 7 160,000,000 8 105,000,000 9 −75,000,000
1. Construct a spreadsheet to calculate the payback period, internal rate of return, modified internal rate of return, and net present value of the proposed mine.
2. Based on your analysis, should the company open the mine?
3. Bonus question: Most spreadsheets do not have a built-in formula to calculate the payback period. Write a VBA script that calculates the payback period for a project.