Question

g he R 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 Cold Goose Metal Works Inc.: Last Tuesday, Cold Goose Metal Works 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 Omicron is 13.2%, but he can't recall how much Cold Goose 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 Omicron. They are Year Cash Flow Year 1 $1,800,000 Year 2 $3,375,000 Year 3 $3,375,000 Year 4 $3,375,000 The CFO has asked you to compute Project Omicron'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 Omicron is the same as that exhibited by the company's average project, which means that Project Omicron's net cash flows can be discounted using Cold Goose's 9% WACC . Given the data and hints, Project Omicron'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 increase, and everything else is unaffected

Answer 1

V fx C =SUM(E32:E35)*-1 D [email protected]% PVIF@9% E31 : X A B 28 29 Year Cash flow 30 A 310 $ -8,605,924 32 1 $ 1,800,000 33 2 $ 3,375,000 34 3 $ 3,375,000 35 4 $ 3,375,000 1.000 0.883 0.780 0.689 0.609 0 E PV of cash flows PVIF @13.2% PVIF@9% Ах В Ах С -8,605,924 $ -8,605,924 1,590,106 $ 1,651,376 2,633,789 $ 2,840,670 2,326,668 $ 2,606,119 2,055,361 $ 2,390,935 1.000 $ .917 $ 0.842 $ 0.772 $ 0.708 $ 36 37 Net present value $ - $ 883,177 38 39 Initial investment $ 8,605,924 $ 883,177 41 A project's IRR will increase if the project's cash inflows increase 40 NPV

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