Question

A firm with a 14% WACC is evaluating two projects for this year's capital budget. After-tax cash flows, including depreciation, are as follows: 0 1 2 3 4 5 Project M - $24,000 $8,000 $8,000 $8,000 $8,000 $8,000 Project N -$72,000 $22,400 $22,400 $22,400 $22,400 $22,400 a. Calculate NPV for each project. Round your answers to the nearest cent. Do not round your intermediate calculations. Project M $ Project N $ Calculate IRR for each project. Round your answers to two decimal places. Do not round your intermediate calculations. Project M % Project N % Calculate MIRR for each project. Round your answers to two decimal places. Do not round your intermediate calculations. Project M % Project N % Calculate payback for each project. Round your answers to two decimal places. Do not round your intermediate calculations. Project M years Project N years Calculate discounted payback for each project. Round your answers to two decimal places. Do not round your intermediate calculations. Project M years Project N years b.. Assuming the projects are independent..which.one(s)..would.you.recommend? -Select- c. If the projects are mutually exclusive, which would you recommend? -Select- d. Notice that the projects have the same cash flow timing pattern. Why is there a conflict between NPV and IRR? -Select-

Answer 1

Pls find below the steps, working and answers:

a) NPV, IRR, MIRR, Payback Period and Discounted Payback period are highlighted in yellow in the below workings;

b) If the projects are independent, both these projects are recommended as the NPV of both is positive, IRR is higher than the discounting factor and Payback is lower than the life of the projects;

c) If the projects are mutually exclusive, then N is recommended as the NPV of the same is higher than that of the Project M;

d) Conflict between the IRR and NPV is due to two factors - the initial investment is different for both these projects and also, the timing of the cash flows and value of the cashflows also different.

YEAR 1 2 3 5 Project M Project N 0 -24,000 -72,000 8,000 22,400 8,000 22,400 8,000 22,400 4 8,000 22,400 8,000 22,400 Discounting Factor 14.0% 0 1 2 3 4 5 YEAR Discounting Factor 1.0000 0.8772 0.7695 0.6750 0.5921 0.5194 IRR Discounted Cash Flow Project M Project N -24,000 -72,000 7,018 19,649 6,156 17,236 5,400 15,119 4,737 13,263 4,155 11,634 NPV 3,464.65 4,901.01 19.86% 16.80% MIRR 17.12% 15.51% 0 1 2 3 4 5 YEAR Cumulative Cash Flows Project M Project N Discounted CumulativeCash Flow Project M Project N -24,000 -72,000 -16,000 -49,600 -8,000 -27,200 8,000 17,600 16,000 40,000 -4,800 -24,000 -72,000 -16,982 -52,351 -10,827 -35,115 -5,427 -19,995 -690 -6,733 3,465 4,901 12 12 12 12 Years 3.00 3.21 12 12 3 PayBack Project M Project N Discounted PayBack Project M Project N 12 12 12 12 12 12 12 2 7 4.17 4.58 12

Computation of IRR: This can be computed using formula in Excel = IRR("range of cashflows", discounting factor%);

Computation of MIRR: This can be computed using formula in Excel = MIRR("range of cashflows", discounting factor%, reinvestment factor%); Here, both discounting factor % and reinvestment factor% are considered same.

Computation of Net Present Value (NPV) based on the Discounted Cash flows; The Discounting factor is computed based on the formula: For year 0, the discounting factor is 1; For Year 1, it is computed as = Year 0 factor /(1+discounting factor%) ; Year 2 = Year 1 factor/(1+discounting factor %) and so on;

Next, the cashflows need to be multiplied with the respective years' discounting factor, to arrive at the discounting cash flows;

The total of all the discounted cash flows is equal to its respective Project NPV of the Cash Flows;

Computation of Normal / Discounted Pay Back Period: Here, the period is computed for each project, based on cumulative normal /discounted cash flows: If the cumulative value is less than or equal to zero, the period is considered as 12 months (it means that the net cumulative cash flow has not yet paid back the initial investment); Once the value turns positive in a particular year, the period for such year is observed at a proportion of actual discounted cash flow to the cumulative CF; This gives the period less than 12 months in such year; Once this is computed, total of all the years is taken and divided by 12, to arrive at the Payback period in no.of years