Question

3. Understanding the IRR and NPV The net present value (NPV) and internal rate of return (IRR) methods of investment analysis are interrelated and are sometimes used together to make capital budgeting decisions. Consider the case of Green Caterpillar Garden Supplies Inc.: Last Tuesday, Green Caterpillar Garden Supplies Inc. lost a portion of its planning and financial data when both its main and its backup servers crashed. The company’s CFO remembers that the internal rate of return (IRR) of Project Gamma is 13.2%, but he can’t recall how much Green Caterpillar originally invested in the project nor the project’s net present value (NPV). However, he found a note that detailed the annual net cash flows expected to be generated by Project Gamma. They are: Year Cash Flow Year 1 $2,400,000 Year 2 $4,500,000 Year 3 $4,500,000 Year 4 $4,500,000 The CFO has asked you to compute Project Gamma’s initial investment using the information currently available to you. He has offered the following suggestions and observations: • A project’s IRR represents the return the project would generate when its NPV is zero or the discounted value of its cash inflows equals the discounted value of its cash outflows—when the cash flows are discounted using the project’s IRR. • The level of risk exhibited by Project Gamma is the same as that exhibited by the company’s average project, which means that Project Gamma’s net cash flows can be discounted using Green Caterpillar’s 9% WACC. Given the data and hints, Project Gamma’s initial investment is ___________ , and its NPV is _________ (rounded to the nearest whole dollar). A project’s IRR will ____________ if the project’s cash inflows decrease, and everything else is unaffected.

Answer 1

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projects (Autosaved) (Autosaved) (Autosaved) - Microsoft Excel (Product Activation Failed) Data Review View Add-Ins Formulas - 2x AutoSum - A 11 pt General AA = = = A Wrap Text Merge Merge & Center Center SF $ - % % 4:0 .00 8.9 Insert Delete Format File Home Insert Page Layout % Cut Calibri Ea Copy Paste Format Painter B I U - D Clipboard Font NQ226 @ foc - NH NI NJ Conditional Format Formatting as Table Styles Cell Styles Fill 2 Clear Sort & Filter Editing Find & Select Alignment Number Cells NK NL NM NN NO NP NO NR NS 218 219 220 221 PV FACTOR AT 13.2% year CFAT IRR IS THE RATE WHERE NPV = 0 OR IN OTHER WORDS, INVESTMENT = PV OF CASHFLOWS SO INVESTMENT = 11474565 222 2 2400000 4500000 4500000 4500000 PV = 0.8834 0.7804 0.6894 0.6090 223 224 225 226 227 228 229 230 231 PV OF CFAT A*B 2120141.34 3511718.21 3102224.57 2740481.07 11474565 4 year CFAT PV FACTOR AT 9% B ANSWERS INITIAL INVESTMENT NPV 11474565 1177569 232 0 233 234 235 -11474565 2400000 4500000 0.9174 0.8417 PV OF CFAT A*B -11474565.20 2201834.86 3787559.97 3474825.66 3187913.45 1177569 0.7722 0.7084 4500000 4500000 NPV = A PROJECT'S IRR WILL DECREASE, IF PROJECT'S CASH FLOW DECREASES & EVERYTHING ELSE IS UNAFFECTED 236 4 237 238 NON Rea invest, EAA MI-np-ir REPLACEMENT S HPR GMAM EAC MACRS NPV RELEVANT BETA LEVERED REPLACEMENT O IRRnpvbeta RATION PBP ARR ferences: E147 BOND OPTION TO WAIT BO 120% STIL _ ELEB * * OENG 29-10-2019