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Build a Model

								12/7/12
Chapter:	10
Problem:	23
Gardial Fisheries is considering two mutually exclusive investments. The projects' expected net cash flows are as follows:
		Expected Net Cash Flows
	Time	Project A	Project B
	0	($375)	($575)
	1	($300)	$190
	2	($200)	$190
	3	($100)	$190
	4	$600	$190
	5	$600	$190
	6	$926	$190
	7	($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
					Use Excel's NPV function as explained in this chapter's Tool Kit. Note that the range does not include the costs, which are added separately.
WACC =	12%		WACC =	18%
NPV A =			NPV A =
NPV B =			NPV B =
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.
	Project A	Project B
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
22%
24%
26%
28%
30%
c. What is each project's IRR?
We find the internal rate of return with Excel's IRR function:
IRR A =		Note in the graph above that the X-axis intercepts are equal to the two projects' IRRs.
IRR B =
d. What is the crossover rate, and what is its significance?
	Cash flow
Time	differential
0
1
2			Crossover rate =
3
4			The crossover rate represents the cost of capital at which the two projects value, at a cost of capital of 13.14% is: have the same net present value. In this scenario, that common net present
5
6
7
e. What is each project's MIRR at a cost of capital of 12%? At r = 18%? Hint: note that B is a 6-year project.
	@ 12% cost of capital			@ 18% cost of capital
	MIRR A =	DII Labs: Use Excel's MIRR function	DII Labs: The difference in cash flows between Project "A" and Project "B".	DII Labs: Net Present Value of "A" discounted at a WACC of 12%				DII Labs: The IRR for the Cash Flow Differential	DII Labs: Net Present Value of "A" discounted at a WACC of 18%	MIRR A =
	MIRR B =			MIRR B =
f. What is the regular payback period for these two projects?
Project A
	Time period	0	1	2	3	4	5	6	7
	Cash flow	(375)	(300)	(200)	(100)	600	$600	$926	($200)
	Cumulative cash flow
	Payback
Project B
	Time period	0	1	2	3	4	5	6	7
	Cash flow	(575)	190	190	190	190	$190	$190	$0
	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	0	1	2	3	4	5	6	7
	Cash flow	(375)	(300)	(200)	(100)	600	$600	$926	($200)
	Disc. cash flow
	Disc. cum. cash flow
	Discounted Payback
Project B
	Time period	0	1	2	3	4	5	6	7
	Cash flow	(575)	190	190	190	190	$190	$190	$0
	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:
PV of future cash flows for B:
PI of B:

Project A

Project B