Question

CAPITAL BUDGETING CRITERIA 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: 3 Project M Project N - $27,000 $9,000 $9,000 $9,000 $9,000 $9,000 -$81,000 $25,200 $25,200 $25,200 $25,200 $25,200 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 1 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

Answer 1

NPV is the difference between present value of cash inflows and initial investment.

IRR is the rate at which present value of cash inflows are equal to initial investment. MIRR is modified IRR which takes into consideration both WACC and reinvestment rate of cash inflows.

NPV, IRR and MIRR are as below:

WACC	14%	14%
Years	Project M	Project N
0	-$27,000	-$81,000
1	$9,000	$25,200
2	$9,000	$25,200
3	$9,000	$25,200
4	$9,000	$25,200
5	$9,000	$25,200
NPV	$3,897.73	$5,513.64
IRR	19.86%	16.80%
MIRR	17.12%	15.51%

Formulas

А В C 1 0.14 0.14 2 WACC Project M 3 Years Project N -27000 -81000 25200 25200 4 0 5 1 6 2 9000 9000 9000 7 3 25200 25200 25200 |=NPV(C2,C5:C9)+C4 =IRR(C4:C9) =MIRR (C4 : C9,C2, C2) 8 4 9000 9000 9 5 NPV(B2,B5:B9)+B4 IRR ( B4: B9 ) 10 NPV 11 IRR -MIRR ( B4 : B9 ,B2,B2) 12 MIRR

Payback period is the time by which project will recover the initial investment through cash inflows.

Project M's initial investment is $27,000 which will be recovered by 3 yearly cash flows of $9,000 each. So, its payback period is 3.00 years.

Project N will recover $25,200*3 = $75,600 in 3 years. the difference between initial investment of $81,000 and $75,600 = $5,400 will be recovered from year 4 cash flow of $25,200. so, its payback period is:

3 years + ($81,000 - $75,600)/$25,200 = 3 years + $5,400/$25,200 = 3 years + 0.21 = 3.21 years

Discounted payback period is calculated same as payback period except cash flows used are discounted using WACC.

WACC	14%			14%
Years	Project M	Discounted cash flow	Cumulative cash flow	Project N	Discounted cash flow	Cumulative cash flow
0	-$27,000			-$81,000
1	$9,000	$7,894.74		$25,200	$22,105.26
2	$9,000	$6,925.21	$14,819.94	$25,200	$19,390.58	$41,495.84
3	$9,000	$6,074.74	$20,894.69	$25,200	$17,009.28	$58,505.13
4	$9,000	$5,328.72	$26,223.41	$25,200	$14,920.42	$73,425.55
5	$9,000	$4,674.32	$30,897.73	$25,200	$13,088.09	$86,513.64

Calculation

A В C. D Е F G 1 0.14 0.14 Discounted cash flow Cumulative cash flow 2 WACC Project N Cumulative cash flow Discounted cash flow Years Project M 4 0 -27000 -81000 B5/(1+$B$2) B6/(1+$B$2)^2 87/(1+SB$2)^3 |B8/(1+$B$2)^4 -B9/ (1+$B$2)^5 -E5/(1+$E$2) E6/(1+SE$2)^2 -E7/(1+$E$2)^3 |-E8/(1+$E$2)^4 -E9/(1+SE$2)^5 5 1 9000 25200 -F5+F6 ЕC5+C6 6 2 9000 25200 -G6+F7 7 3 9000 -D6+C7 25200 8 4 EG7+F8 9000 -D7+C8 25200 25200 G8+F9 9000 9 5 D8+C9

In the above table in column D, we can see that project M will recover $26,223.41 in 4 years. the remaining initial investment it will recover in year 5.

Discounted payback Project M = 4 years + ($27,000 - $26,223.41)/$4,674.32 = 4 years + $776.59/$4,674.32 = 4 years + 0.17 = 4.17 years

In the above table in column G, we can see that project N will recover $73,425.55 in 4 years. the remaining initial investment it will recover in year 5.

Discounted payback Project N = 4 years + ($81,000 - $73,425.55)/$13,088.09 = 4 years + $7,574.45/$13,088.09 = 4 years + 0.58 = 4.58 years