Weighted average cost of capital

Phase 1

Capital Expenditure Planning & Budgeting for Universal Parts Company
Universal Parts Company - Estimated Cash Flows (CF) for Projects A & B (in thousands of dollars):
	Year	CFA	CFB	Assumme that tax effects, depreciation, salvage values, and all operating costs have been included in the cash flows
	0	($1,000)	($1,000)
	1	$100	$700
	2	$600	$500
	3	$800	$200
Net Present Value (NPV)
(1) Determine each project’s NPV.
WACC =	%	Activity: Choose both projects if two projects are independent, and their NPVs are positive
		Activity: Choose the project with the higher positive NPV if the two projects are mutually exclusive
NPVA =	ERROR:#VALUE!
NPVB =	ERROR:#VALUE!
Internal Rate of Return (IRR)
(1) Determine each project’s IRR.
The internal rate of return (IRR) is that discount rate which forces the NPV of a project to equal zero.
				Activity: Double-click on the equation to find out how you can insert an equation.
The solution to this equation can be found using Excel's IRR function.
IRRA =	18.1%	Activity: Choose both projects if two projects are independent, and their IRRs are higher than the WACC
IRRB=	23.6%	Activity: Choose the project with the higher IRR in excess of WACC if the projects are mutually exclusive
Crossover Rate
(1) Draw NPV profiles for Projects A and B. At what discount rate do the profiles cross?
							Project	Project
						WACC	A	B
							ERROR:#VALUE!	ERROR:#VALUE!
						0%	500.00	400.00
						5%	330.53	292.95
						10%	187.83	199.85
						15%	66.66	118.27
						20%	-37.04	46.30
						25%	-126.40	-17.60
							Year	CFDifference
							0	$0
							1	($600)
	IRR = crossover rate =			8.68%			2	$100
							3	$600
Modified Internal Rate of Return (MIRR)
(1) Find the MIRRs for Projects A and B.
Activity: MIRR is the internal rate of return for a series of a project’s cash flows, taking into account the cost of investment and interest on reinvestment of cash.
Activity: Projects A and B's modified IRRs can be solved for by using Excel's MIRR function, entering their cash flows and using the WACC as both the discount rate and the reinvestment rate.
MIRRA =	ERROR:#VALUE!		By the MIRR criteria, Project B is preferred to Project A, which is consistent with the NPV decision.
MIRRB =	ERROR:#VALUE!
Payback Period
(1) Find the paybacks for Projects A and B.
Payback Calculations
Project A		Years	0	1	2	3
			|	|	|	|
		Cash Flow	-1,000	100	600	800
		Cumulative Cash Flow	-1,000	-900	-300	500
Payback A = 2 + 300/800 =			2.4
Project B		Years	0	1	2	3
			|	|	|	|
		Cash Flow	-1,000	700	500	200
		Cumulative Cash Flow	-1,000	-300	200	400
Payback B = 1 + 300/500 =			1.6

NPV Profiles

#VALUE! 0.0 0.05 0.1 0.15 0.2 0.25 500.0 330.525861138106 187.8287002253942 66.65570806279288 -37.03703703703695 -126.4 #VALUE! 0.0 0.05 0.1 0.15 0.2 0.25 400.0 292.9489256019867 199.8497370398195 118.2707323087041 46.29629629629653 -17.60000000000002

WACC

NPV ($)

Sheet2

Sheet3

NPV = $0 = CFt (1+ IRR)tt=0

n

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